Self-employment: Elephant in the room

While nearly half of the labour force in India is self-employed, persistent low standards of living on a large scale imply that not many of these are ‘entrepreneurs’. Much of the self-employment is in low-productivity occupations or businesses. In this article, Gurbachan Singh contends that if financial institutions, labour laws, redistributive policy, and educational certification worked well, low productivity self-employment would give way to more efficient and productive businesses.

The proportion of the labour force that is self-employed in India is very large at 48.4% (Ghose 2016). Why is it so?

Self-employment and entrepreneurship are different

It is not plausible that all the self-employed people in India are entrepreneurs in the sense in which the term is usually used in economics (Schumpeter 1961); if India had so many entrepreneurs (and a decent redistributive policy), it is very unlikely that there would be persistent low standards of living on a large scale! The term entrepreneur is associated with significant initiative, insight, vision, foresight, fresh thinking, conviction, and stamina, and with specific concepts like creative destruction¹. The term self-employment in contrast, simply refers to anybody who is working for oneself instead of working for a wage or salary in an organisation run by others, which is the case of wage employment.

In a developed country (DC) like the US, self-employment is much less; it is 10.1% of the labour force (Hipple and Hammond 2016). Unlike India, in a country such as the US, the gap, in practice, between the terms self-employment and entrepreneurship can be quite small. Anyone who is an entrepreneur obviously becomes self-employed instead of taking up a job (this is not always the case in India). Indeed, it is often the other way round as well, in a DC. Self-employment quite often implies entrepreneurship in DCs.

In DCs, there are some exceptions where businesses are inherited. In these cases, self-employment need not imply entrepreneurship. However, such cases are not permanent. There are also cases of self-employment where one would like to be one’s own boss or follow one’s own dream. There is, however, little reason to believe that these are much less widely prevalent in the US than they are in India. So, large self-employment in India needs an explanation.

In a DC, if a job is not available, then a person would be unemployed given that there is hardly an alternative. After all, if an unemployed person is not an entrepreneur, they cannot become self-employed and set up a competitive or even a viable business. The competition is very tough there, often with large, established businesses that have access to large funds, modern technology and management, lobbying power, and so on. Given that self-employment is usually not an option, an unemployed person would, for a living, use up savings and/or get some variant of an unemployment benefit from the government; they may also be able to borrow. All this is not the story in India.

In economics, we have the notion that under free markets, in the absence of a recession if a person does not get a suitable or adequately paying job, this only means that the person is being unreasonable in their demands. They are, in practice, for the purposes of economic analysis and policymaking, not to be counted among the unemployed; instead they may be viewed as outside of the workforce. There is merit in this argument in the context of DCs but in LDCs like India the situation can be very different.

Labour and capital

We have two stylised facts here. First, there is large self-employment in India. Second, the proportion of non-financial savings in total savings is large. Non-financial savings are invested in real assets that include not only real estate and gold but also, what are often called, owner-managed enterprises. The two stylised facts are related (Pant et al. 2009). To see this, consider two endowments with a household, namely, labour and funds. Just as it can be difficult to find a good job where one can use one’s labour, similarly it can be difficult to find a safe and understandable outlet where one can make a financial investment which gives decent returns. So, real or non-financial investments can be large. This is, in general, not efficient.

Given the lack of suitable jobs and given the lack of suitable avenues for financial investment, people opt for self-employment and use their funds in owner-managed enterprises. They need to set up on their own because there is hardly any social security and there is a realisation that consuming one’s own limited wealth cannot take one far for long because a job may not be coming for years or possibly decades, even a lifetime! Of course, there are others who have hardly any such funds; they have little choice other than to take up whatever kind of job is available.

There is another feature of self-employment and owner-managed enterprises. Tax evasion can be relatively easier in this case than for entrepreneurs who operate on a large scale with the help of professionals who have some leeway such that the direct control over all matters (including tax affairs) is not with one person or even a few persons. It is well-known that there is considerable tax evasion in India. One of the reasons is the wide prevalence of self-employment and owner-managed enterprises.

Self-employment and owner-managed enterprises can take various forms. Owner-managed enterprises can include units run by hawkers, shopkeepers, merchants dealing in wholesale trade, and distributors. There can be owner-managed workshops; small – manufacturing, agricultural or service enterprises; or medium-sized enterprises. So, the size and nature can vary considerably. It is important to note that some self-employed people, like entrepreneurs, could be offering jobs to others, which may get categorised as wage employment.

Policy

Besides the above reasons, self-employment is large in India in an environment where some government policies encourage owner-managed enterprises. This is clear from the policies related to small and medium enterprises; it is also clear from de-jure and de-facto policies related to, say, street vendors in India. But what else can be done?

At present, there are labour laws that fix the minimum wage at a level that is above the market-clearing level. This leads to low wage employment in the organised sector. It must be added, however, that the usual emphasis on labour laws in the context of increasing wage employment is somewhat misplaced. This is evident from the fact that there has been some de-facto dilution of labour laws (firms use ‘contract labour’). Despite this, wage employment is not very large. Why? Before we come to this, let us, in any case, consider an improved version of the current minimum wage laws.

At present, the onus is on the firms to pay a minimum wage. However, the role of paying a minimum ‘wage’ (more generally, ensuring a minimum standard of living) can be shifted from the employer to the government (Friedman (1987) following Lady Juliet Rhys Williams (1898–1964) though the basic idea is more familiar as the concept of a negative income tax). This is not to absolve the business sector or the rich from their social responsibility. It is only to ensure that the labour market clears, wage employment rises, and self-employment falls. The social responsibility of the business sector and the rich can take the form of more taxes to the exchequer, and the additional taxes can be used to finance the gap between the market clearing wage and the minimum ‘wage’. Relatedly, the public authorities need to improve public administration, laws and procedures so that the tax collection goes up. All this is important but it is not sufficient.

At present, there are difficulties in financial markets and financial intermediation, which come in the way of people making financial investments. If there is an improvement in this sphere, it would reduce the somewhat compelling need to invest funds in owner-managed enterprises. Less investment in owner-managed enterprises goes alongside less self-employment. So, further financial development can lead to less self-employment.

For financial development, there is a need to reduce financial repression in banks. There is also a need to reduce barriers to entry in financial intermediation; this can make financial intermediation more competitive and the size of the market for, say, banking can go up to its optimum level. It is also important to have low and stable inflation so that the real returns on debt instruments are decent; this can encourage financial investments.

Financial development is by itself important (Levine 1997). But it is also important from another viewpoint; financial development, as explained earlier, leads to less self-employment. Interestingly, the reverse relationship also holds. A fall in self-employment can contribute to financial development. The reason is simple. A reduction in self-employment implies fewer owner-managed enterprises. So, there would be less investment of funds there; these funds can then enter financial intermediaries or financial markets.

There can be a need for other policies as well for reducing self-employment, for example, policies that are geared towards appropriate training and education, and equally importantly, credible certification process. But that is another story.

Conclusion

Nearly half the labour force in India is self-employed but not many are entrepreneurs. So, inefficiency is to be expected here. This is indeed borne out by observations of development economists that much of the self-employment is in low-productivity occupations or businesses in India. Accordingly, there is a need to reduce self-employment and increase wage employment.

If financial institutions, labour laws, redistributive policy, and educational certification work well, the low productivity self-employment would give way to more efficient and productive businesses.

Note:

Creative destruction refers to the incessant product and process innovation mechanism by which new production units replace outdated ones. It was coined by Joseph Schumpeter who considered it ‘the essential fact about capitalism’.