Self-Employment as an Alternative to Unemployment

Data from the NLSY show that more than a quarter of all younger men experience some period of self-employment. Many of them return to wage work. This paper analyzes a simple model of job search and self-employment where self-employment provides an alternative source of income for unemployed workers. Self-employment is distinct from wage sector employment in two important respects. First, self-employment is a low-income, low-variation alternative to wage work. Second, once a worker enters self-employment, he loses eligibility to receive unemployment insurance benefits—at least until he returns to wage sector employment. The model suggests that flows into self-employment are countercyclical and flows out of self-employment are procyclical. Data from the NLSY for males at least 21 years of age are used to investigate how demographic and economic variables influence the decision to become self-employed. Fixed effects and random effects logit results indicate that young men are more likely to be self-employed when their wage work opportunities are more limited. Specifically, higher local unemployment rates lead workers to self-select into self-employment, as does past unemployment experience. The process is different for Whites and Nonwhites with education being irrelevant for White self-employed workers. In contrast, for Nonwhites higher education reduces the probability of entering self-employment.