Eli Dourado on the Virtues of Self-Employment from a Business Cycle Perspective

Eli Dourado offers an illuminating discussion of the the robustness of self-employment:

Putting aside whether self-employment is rising, I am convinced that self-employment is desirable, other things equal, from a business cycle perspective. This is true whether you are a Keynesian or a ZMP theorist. A popular Keynesian story is that when demand falls, workers refuse to accept nominal wage cuts without a corresponding decline in morale, making them less productive. Consequently, firms prefer to fire a fraction of the workforce and then announce “no more layoffs” rather than cut wages for everyone. Promises from laid-off workers to work at half their former salary with no decline in morale are not credible. Self-employment maybe doesn’t solve the problem of low morale during a recession, but it at least obviates the need to make promises about future work at low salaries. When demand falls, self-employed workers accept lower wages, at least until they find other employment, because what choice do they have? And there is no one they need to convince to keep them on staff.

There is something to the morale story, although I have a hard time believing it can explain a protracted recession. I’ve been pushing a version of ZMP theory that considers the agency costs associated with overseeing employees as roughly a fixed cost (I consider this version a complement to, not a substitute for, other versions of ZMP that are based more on coordination and recalculation). Although we teach in freshman econ that the wage equals the marginal product of workers, workers also have to cover the overhead associated with hiring them, which is often substantial. A major part of the cost of employing workers is the cost of supervising them, and this cost is fixed with respect to demand. If we suppose that a worker can produce $30/hour and costs $15/hour to employ, the worker will take home $15/hour in wages, his net marginal product. If demand falls so that the worker’s output is valued at $20/hour, and the cost of employing him remains $15/hour, his net marginal product falls to $5/hour, which is below the minimum wage. The employee is therefore unemployable, even if his wage demands are totally flexible, and he will be fired.

In this example, a 33% decline in the value of output resulted in a 67% decrease in net marginal product and a 100% decline in employment. Fixed management costs, therefore, tend to amplify the effect on workers’ employment prospects of shocks to demand (or supply). Because there are no agency costs associated with self-employment, demand and supply shocks are not amplified among the self-employed. Employment is fragile; self-employment is robust. We should expect that a self-employed economy would not be as susceptible to long recessions as an employed one. [Emphasis added]

This story dovetails nicely with Eli’s earlier observations regarding labor market regulation and technologies of control. We tend to think of GDP and employment levels as tightly linked — if one goes up, so should the other — but in a laissez-faire labor market, employment levels would presumably go up as people grow more and more willing to accept very low wages. Most people living in affluent societies find this idea profoundly distasteful, perhaps because, in Michael Munger’s framework, it implies exchanges that are not truly euvoluntary, i.e., the workers accepting very low wages are only doing so because the gap between the “best alternative to a negotiated agreement” (BATNA) between the potential employer and the potential employee is too large. Self-employment helps mitigate the anxiety associated with non-euvoluntary exchange. While there are many taboos surrounding employment relationships, there are, for whatever reason, far fewer around buying goods and services at low cost.

This is why the (apparent) return of partial self-employment is so interesting. The ideology of the wife-as-homemaker was, if I understand correctly, an artifact of the early twentieth century. In earlier American eras, it was common for women to engage in various kinds of market production alongside household production, e.g., taking in washing, boarders, etc., while men embraced broadly complementary economic roles in the production partnership. Employment was fragmentary, not unitary, and it existed along a continuum, with elements of barter, alliance-strengthening, etc., as well as cash transactions playing a role. This has always been true in varying degrees — much depends on what we think of as work and what we think of as exchange — but it does seem as though the rise of various web-based sharing and crowdsourcing and ecommerce platforms is ushering in new(ish) kinds of market work:

In response to Reihan, Justin Wolfers tweets that, in fact, self-employment is falling, citing BLS data. I’m not totally persuaded that the metric Wolfers points to, “Self-employed workers, unincorporated,” actually captures all the movement we are observing. To the extent that more people are interested in self-employment, thicker markets in incorporation services develop, so it’s possible that unincorporated self-employment could fall even as total self-employment increased. More importantly, a lot of people have several income streams, only one of which is a full- or part-time job. Unless I am mistaken, these people show up in the household survey as employed either full-time or part-time, even though their Etsy/Kickstarter/App Store/Kindle Single incomes are economically or otherwise important.

I was in that category last year. I had a part-time job, but I earned more money through the Mac App Store and various freelance economist gigs than I did from my job. I have a good friend who works part time so that she can pursue her passion for felting through Etsy (and increasingly, other avenues). I have no idea how substantial her Etsy income is, but I know that Etsy is an important part of her life. [Emphasis added]

To descend into glib political analysis for a moment, my sense is that a universe in which a much larger share of workers derive at least part of their income from self-employment would be a healthier universe. The partially self-employed are less dependent on employers, and perhaps even more independent-minded in a broader sense. Self-employment helps cultivate the sensibilities that are most amply rewarded in the age of the infovore.

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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