Explaining international variations in self-employment: evidence from a panel of OECD countries

Southern Economic Journal, Oct, 2004 by Simon C. Parker, Martin T. Robson

1. Introduction

In recent years there has been growing awareness of the importance of self-employment for growth and employment creation. Governments around the world are increasingly implementing policies designed to promote self-employment (see, e.g., OECD 1998). Yet relatively little is known about the determinants of self-employment, especially the effects on the self-employment rate of government policy instruments. As we show in this article, self-employment rates in the OECD display marked variations across countries, both in cross-section "snapshots" and over time. The objective of this article is to explain these disparate patterns by identifying the determinants of self-employment rates, placing special emphasis on government tax and transfer policies.

Previous studies of the determinants of national self-employment rates have been confined to a handful of countries. (1) Although they have been able to shed some light on the causes of self-employment rates within particular countries, they suffer from two drawbacks. First, they cannot explain the pronounced observed differences in self-employment rates between countries. Second, national time-series studies tend to work with only short spans of data, consigning tests of statistical significance to lack of power, and hence reliability.

Both of these problems can be addressed by exploiting the panel nature of available OECD data. Panel data enjoys the advantage over static cross-sections or single-country time-series data of looking at more than just one time period and country. Trends in self-employment rates and cross-country differences in these rates are both of interest in their own right. This motivated the influential article of Acs, Audretsch, and Evans (1994; henceforth AAE), as well as Staber and Bogenhold (1993), Robson and Wren (1999), Blanchflower (2000), and OECD (2000). These articles all used ordinary least squares (OLS) to estimate self-employment regressions based on pooled cross-section time-series or fixed/ random effects specifications. Yet recent developments in the analysis of panel data regression models cast doubt on the validity of the findings from these studies. Although it has long been recognized that OLS yields biased and inconsistent estimates in dynamic panel data regression analysis (see Nickell 1981), recent work has shown that OLS will also produce biased and inconsistent estimates even in regular panel data models when--as is shown to be the case here--variables possess unit roots. (2) In addition, conventional significance tests based on OLS estimates cannot be used to reliably identify genuine relationships between variables. This problem is well known in the traditional time-series econometrics literature (e.g., Phillips 1986), where it prompted the development of cointegration estimators (Engle and Granger 1987; Johansen 1988). Only recently have these econometric techniques been extended to the panel framework. A key advantage of these techniques is that by utilizing cross-country information, panel unit root and cointegration tests are much more powerful than for the conventional single-country case, making inference more reliable. This point is especially important in view of the low power of conventional unit root and cointegration tests (Banerjee et al. 1993). (3)

In this article we investigate the determinants of serf-employment using a panel of annual data on 12 OECD countries spanning the period 1972-1996. We use a wider range of explanatory variables than previous studies, paying particular attention to variables under the direct control of governments: average rates of personal income tax, employers' social security contributions, and benefit replacement rates. We find that the emphasis on macroeconomic and demographic variables in previous studies appears to have been misplaced. Macroeconomic variables are found to be neither significant nor robust determinants of self-employment rates in the OECD. Instead, government policy variables appear to play a central role. In particular, we show that serf-employment rates are positively and significantly related to average income tax rates and negatively and significantly related to the benefit replacement rate. We also show that panel OLS would have failed to uncover these results.

The article is organized as follows. Section 2 documents the variation in national self-employment rates in the panel, describes the data, and presents several hypotheses that may explain these patterns. Section 3 briefly describes the panel unit root and cointegration techniques and presents the results. Section 4 concludes the article.

2. Data and Possible Explanations

Annual data for the rate of nonagricultural self-employment in 12 OECD countries over the period 1972-1996 are plotted in Figure 1 using various issues of OECD Labor Force Statistics. The numerator is the number of employers and own account workers in nonagricultural civilian employment, whereas the denominator includes all persons in civilian employment in the nonagricultural sector plus the numbers in unemployment. The agricultural sector is excluded, as self-employment rates in this sector are likely to be heavily influenced by historically and culturally determined traditions of family ownership and factors other than those that influence self-employment rates in the rest of the economy. (4)