Great opportunities or poor alternatives: self-employment, unemployment and paid employment over the business cycle

In this paper, we study the flows between self-employment, unemployment and paid employment, and how these vary over the business cycle. First, we document these flows in the data, paying particular attention to previous labor market outcomes for workers entering self-employment, and subsequent labor market outcomes for those leaving self-employment, and how these are affected by cyclical conditions. Second, we construct a two-ladder equilibrium model of a frictional labor market capturing these flows: workers search both on and off the job, and receive business ideas while in any of the three states: self-, paid employment and unemployment. We study this model in an environment with aggregate shocks, which affect both the productivity of matches in the paid-employment sector, and the profitability of ideas for the self-employed. Third, we (plan to) calibrate to see how well it can quantitatively account for observed patterns over the business cycle. These allow us to have a notion of entry into self- employment by "opportunity" (highly profitable ideas), and "necessity" (lack of alternatives in paid employment), and how these vary over the business cycle, and to quantify "prosperity pull" of self-employment in good times, and "recession push" in bad times. Finally, we plan to study the impact of labor market policies on self-employment, and on unemployment, taking into account the option to enter self-employment.