Self-employment and poverty in developing countries Updated

Poverty and labor markets are linked

The first UN Sustainable Development Goal (SDG), like the first Millennium Development Goal (MDG) before it, for good reason, is to eradicate extreme poverty and hunger. Despite the progress that has been made, worldwide poverty remains enormous.

Because labor is the main asset of the poor, unemployment is often thought to be the main reason for poverty. This is wrong. In a given week, some 190 million people are unemployed and earn nothing. This is a large number, but it pales beside the 730 million people who are employed but earn so little, in cash or in kind, that they and their families cannot achieve a standard of living of even US$3.10 per person per day [3]. (The US$3.10 figure is the current international definition of poverty in purchasing power parity (PPP) dollars. A lower figure, US$1.90 (PPP) is used internationally to define extreme poverty. More than 300 million workers around the world are in extreme poverty.)

In view of these figures, what the world has is an employment problem more than an unemployment problem [4]. What differentiates people who are poor from those who are not, then, is not whether they are employed, but how much they and other household members earn from the work they do. Fully half of the extremely poor in urban areas operate a non-agricultural business, according to an 18-country study [5].

Most workers in developing countries are self-employed

In developing economies, as noted, many poor people—often a majority—are self-employed in both urban and rural areas and inside and outside agriculture. The self-employed include own-account workers and contributing family workers. Own-account workers are self-employed individuals who do not employ others. Contributing family workers are those workers who hold self-employment jobs as own-account workers in a market-oriented establishment operated by a related person living in the same household. The ILO defines vulnerable employment in exactly the same way that self-employment is defined here (i.e. own-account workers plus contributing family workers), but that terminology is not widely used. ILO figures show that the self-employment rate for the world as a whole is equal to 42.5%. The extent of self-employment within countries varies inversely with the level of economic development, using the ILO's country classification scheme: 76.5% of all employment in developing countries, 46.2% in emerging countries, and 10.0% in developed countries. These three groups of countries are respectively called low-income, middle-income, and high-income in other parlance. Broken down by regions of the world, sub-Saharan Africa is tied with Southern Asia for the highest rate of vulnerable employment—both have a rate of 72.1%. Figure 1 displays these rates for each of the ILO's country groupings.

Self-employment is not the same as entrepreneurship or informal employment

Self-employment is sometimes equated with entrepreneurship, but this can be misleading. To many people, “entrepreneurship” conjures the image of a risk-taker setting up a business with the intent of making it grow and prosper. In developing countries, however, the goal of much self-employment is far more modest: to earn money for a time—preferably, a short time—before transitioning to a more remunerative activity.

An example is saving money to buy a package of 20 cigarettes and then selling them individually at a higher unit price and surviving on the profits. Workers (mostly young men) engaged in such survival self-employment can hardly be called “entrepreneurs” in the everyday sense of the term. They engage in such activities reluctantly and only until they can find something better. The majority of self-employment enterprises lack the potential to grow, as studies in Sri Lanka, West Africa, and elsewhere demonstrate.

Self-employment is also sometimes equated with working informally. But equating the two is unhelpful. “Working informally” and the associated terms “informal economy” and “informal sector” are not defined consistently in empirical studies, so “informality” means different things to different people. And even when the conceptualization is clear, as when informal employment refers to work outside the protection and regulation of the state, it is difficult to quantify this concept in the data.

While many people who engage in unprotected and unregulated work are paid workers, not self-employed, there are only vague estimates of how many there are. Even less is known about how many self-employed people are engaged in informal activity according to the unprotected/unregulated definition and how many are not. The evidence points to most own-account enterprises and other very small firms being unregistered despite government efforts to get them to register [6].

Does self-employment reflect choice—or lack of choice?

The literature distinguishes two quite different reasons for self-employment. Some are self-employed because they have ideas for profitable businesses and seek to become successful entrepreneurs. An example is a backyard auto mechanic who learned his trade as a paid employee in an established garage, then left voluntarily to set up his own business. Others are self-employed because they do not have the possibility of being wage employees, a condition most of them appear to prefer. In this sense, they are self-employed because they have no choice. They are too poor to remain unemployed and earn nothing.

Duality within self-employment is found throughout the developing world. Controversy remains over the relative importance of the choice and no-choice routes to self-employment, and more research is needed to investigate this issue in specific countries. One careful study concludes that two-thirds of self-employment in the developing world as a whole results from individuals having no better alternatives [7]. Another finds an approximately equal split in non-OECD countries [8]. It is crucial to have data on how many of the self-employed in developing countries had previously been wage employees and could have continued in wage employment but left their jobs willingly in order to create their own enterprise. Although little is known about this, it seems to be relatively rare.

Self-employment and poverty are closely linked, albeit not perfectly. The international network Women in Informal Employment: Globalizing and Organizing (WIEGO) finds that the self-employed are concentrated in high-poverty-risk, low-average-earnings categories [9]. In the words of one study of the working poor: “Perhaps the many businesses of the poor are less a testimony to their entrepreneurial spirit than a symptom of the dramatic failure of the economies in which they live to provide them with something better” [5].

How policies harm the working poor: Hindrances, restrictions, and regulations

Street vendors are ubiquitous throughout the developing world. They sell handicrafts, ice cream, lottery tickets, and just about everything else. But South Africa is different [10]. In cities like Johannesburg, Cape Town, and Durban, street vending is entirely absent or confined to a very restricted area. The reason for this is local government policies: for example, Durban had issued just 872 trading permits as of 2005, far fewer than the number of people who want to be street traders. The government arrests, fines, or jails unlicensed traders and confiscates their inventory. This all-too-real threat deprives countless people of a livelihood.

Some regulations are needed to protect against abuses. Products that are illegal or dangerous need to be regulated. And some sales practices are threatening to customers, who need to be protected. But some regulations and restrictions needlessly hinder the self-employed poor and prevent them from earning even a meager living.

Two groups of beneficial policy measures to support the self-employed

Policy interventions to boost the labor market earnings of the self-employed can be put into two broad groups: those that raise the returns to the self-employed in their current activities and sectors, and those that help the self-employed transition into new, better-paying wage activities.

Policies that can raise the returns to the self-employed in their current activities and sectors include:

• adopting a positive policy stance toward the self-employed that avoids hampering them;

• designing productive inputs (such as irrigation equipment) that can raise the productivity of the self-employed;

• providing poor farmers with more to work with, such as more land, equipment, extension and outreach services, and fertilizer and other inputs;

• facilitating off-farm wage employment and self-employment in rural non-farm enterprises;

• making capital available to the poor at affordable rates;

• building skills and business know-how;

• stimulating microfinance and microfranchising.

Other policies can expand opportunities for wage employment so that the self-employed poor can move into more remunerative employment. These include general measures affecting labor markets:

• Stimulating job-enhancing economic growth.

• Working toward a more open, but not predatory, international trade environment.

• Encouraging more foreign aid.

• Harnessing the energies of private companies.

Policies can also include labor market measures aimed specifically at generating more wage employment:

• Avoiding prematurely high labor costs.

• Removing excessive barriers to employment.

• Increasing workers’ skills and productive abilities in areas where job vacancies go unfilled because people lack the skills needed to fill them.

• Establishing workfare and other programs aimed at creating jobs for the poor.

The highest priority interventions vary from country to country, and from place to place and group to group within a country. Countries have different objectives and different trade-offs and constraints on both the policy and the budget sides. The constraints bind differently, the most obstructive constraints differ by circumstances, and the most cost-effective way of intervening to relax the constraints also varies. The World Bank's 2013 World Development Report entitled Jobs offers an eight-way typology for prioritizing policy interventions for different categories of countries [11].

In all countries, however, policies are needed that provide opportunities for poor, self-employed workers to earn more at their current activity or move into more remunerative activities. To be avoided are policies, evident in many countries, that make life more difficult for the self-employed and deprive them of the opportunity to earn a living.

As always, no single policy or group of policies will work everywhere. But there are some particularly promising interventions that have succeeded in multiple contexts, and some of them are highlighted in what follows.

Some especially promising policy interventions to assist the self-employed poor

Four interventions appear to be particularly effective and could guide future efforts to improve employment opportunities for the poor [2]:

• focusing economic growth on improving the earning opportunities of the poor;

• creating off-farm employment opportunities;

• training people for wage employment; and

• making microcredit affordable.

These policy priorities are not the only potentially powerful policy interventions. Entrepreneurship policies might also be worth pursuing. But these four policy priorities hold particular promise and have demonstrated their effectiveness in a range of settings.