Urban Informal Employment and Self-Employment in Developing Countries: Theory and
Evidence
Author(s): Gustavo Yamada
Source: Economic Development and Cultural Change, Vol. 44, No. 2 (Jan., 1996), pp. 289-314
Published by: The University of Chicago Press
Stable URL: http://www.jstor.org/stable/1154404
Accessed: 03/01/2010 04:21

I. Introduction

This article summarizes the results of an investigation of the theoretical and empirical aspects of the urban informal and self-employment sec-tor in developing countries. The central questions are whether individ-uals choose to work in this sector, earn competitive incomes, and obtain returnst o their entrepreneurial abilities.

Two main facts motivated this research. First, according to a re-cent study, the main employment of at least one out of every five members of the urban labor force in developing countries is informal self-employment.'S econd, our understandingo f the economics of the informal self-employment sector is still sketchy because there is a lack of appropriate data in developing countries.

After 2 decades of academic and political debate, the role of the urban informal sector in developing countries is still a controversial issue. My basic hypothesis is that people are self-employed in the urban informal sector by choice. According to this view, the prolifera-tion of informal self-employment in developing countries is not eco-nomically inefficient. The sector responds to a demand for urban services and small-scalem anufacturing. It absorbst he supply of entre-preneurial talent, which in turn enhances the sector's capacity to pro-vide competitive earnings. This interpretation of informal self-employment contrasts sharply with the alternative, popular view of the informal sector as an involuntary and transitory employment op-tion that provides meager earnings.

The testing of these two opposite hypotheses with appropriate data and empirical tools is not only of academic interest but also of practical importance. Policies for the informal sector will depend on policymakers' perceptions of its role in the economy. For instance, traditionallyt hey have tended to view the informals ector as backward. Consequently, their policies have ranged from straight prohibition of the sector to a poverty-alleviation orientation. However, if this arti-cle's hypothesis is closer to reality, the attitude toward this sector should be more neutral.

Based on data from Lima, Peru, for 1985-86 and 1990, the results of this research generally support the hypothesis of voluntary self-selection and higher earnings in informal self-employment. Likewise, evidence from labor movements across sectors over time shows an active process of searching for the best employment sector to max-imize income. Thus, only successful entrepreneursr emaini n the infor-mal sector on a permanent basis. Other important results are the identi-fication of the public sector's changing role in the labor market and of the disadvantageous situation of informal wage earners who are slow to move to better economic alternatives.

For this study I used the data sets provided by the World Bank Living Standards surveys in Peru for 1985-86 and 1990. They deal with questions about the economics of informal self-employment and its relationship with other labor market outcomes as well as with the general macroeconomic context. The main advantage of these house-hold surveys is that they capture detailed information on the incomes of the self-employed as well as of wage employees in addition to other relevant information on individual socioeconomic characteristics.

Section II includes a short discussion on the dichotomies of self-employment versus wage earning, and informal- versus formal-sector employment. Section III presents a simple general equilibrium model of three sectors, including the urban informal self-employment (UIS) sector, that guides the empirical analysis. Section IV outlines the em-pirical methodology. Section V summarizes the results on earnings differentials, selectivity, and the evolution of the relative size of the UIS sector from two cross sections, 1985-86 and 1990. In Section VI I study a panel subsample present in both the 1985-86 and 1990 pe-riods. Section VII concludes the article. Finally, the Appendix briefly describes the earnings estimation procedure.