Self-Employment and Human Capital

This chapter proposes a framework to understand how the structure of production in the process of economic development embodies a shift from self-employment to wage work. A labour allocation model with human capital is shown to be an important determinant of the structure of employment. An important input that has not been given adequate attention and that enables the transition to formality is entrepreneurial and management skills. Managers of informal enterprises are considerably less educated than those of formal enterprises. Similarly, self-employment is associated with noticeably lesser levels of education than wage employment. We posit that the acquisition of human capital increases managerial ability and the income from self-employment whilst at the same time raises the wage-earning capacity of the individual as higher costs of acquiring skills are compensated for with higher wages in the wage labour market. We show that as human capital acquisition increases in the initial stages it is allocated to self-employment as it positively impacts managerial ability and the efficiency of production. However, at higher levels of human capital there is sufficiently higher wage-earning possibilities in the wage labour market and self-employment declines. Lack of human capital skills would then be the very important constraint on transitioning from low income self-employment to wage employment and of managers in informal enterprises transitioning to larger formal enterprises.