Fact or Fallacy: Can Self Employment Improve Economic Opportunities for Low Skilled Workers?

December 2010

Moderator: Welcome to the Federal Reserve Bank of Atlanta's Small Business podcast series. I'm Alicia Robb with the Ewing Marion Kauffman Foundation and visiting scholar with the Federal Reserve Bank of Atlanta. Today we're talking with Dr. Magnus Lofstrom, research fellow at the Public Policy Institute of California.

Small businesses and the self-employed individuals who start and run them are considered a critical component of our economic recovery. For low-skilled workers, it may be the only opportunity to improve their earnings in an increasingly knowledge-driven labor market, and many communities and states have pursued strategies to encourage entrepreneurship. However, few have looked to this strategy to target low-skilled workers in particular. In this podcast, we will discuss some of the trends and policy implications of self-employment among low-skilled workers.

Dr. Magnus Lofstrom has been with the Public Policy Institute of California since 2008. He is a labor economist with expertise in immigration, minority self-employment, and education. The Public Policy Institute of California is a nonprofit, nonpartisan think tank addressing issues such as immigration, education, governance, the environment, and economic development.

Dr. Lofstrom, thank you for joining me today.

Magnus Lofstrom: Thank you. Good to be here.

Moderator: In your paper "Does Self-Employment Increase the Economic Well-Being of Low-Skilled Workers?" you analyze the economic returns of business ownership among low-skilled workers, and you address the question of whether self-employment is a good option for low-skilled individuals that policymakers might consider encouraging. Please begin our discussion by defining the terms "low-skilled worker" and "economic well-being."

Lofstrom: So, for low-skilled, we wanted to use a simple and transparent definition, so we defined those workers who have no education beyond high school as being low-skilled workers. In terms of economic well-being, here we're referring to the ability to financially provide for yourself or your family, and we think this is most importantly reflected in the person's earnings.

Moderator: With so much focus on knowledge-based and high-skill jobs, why does your paper center on low-skilled workers, and particularly on self-employment among low-skilled individuals?

Lofstrom: Well, there are really limited labor market opportunities for low-skilled workers, and it continues to diminish over time. And this is costly both to the individuals themselves, their family, and society as well. Low-skilled compared to higher-skilled is associated with lower earnings, which means lower taxes, higher unemployment rates—and, also, low-skilled workers are more likely to be on welfare compared to relatively more skilled workers.

The question that we're trying to address in this paper then is if self-employment should be considered a policy tool, then to broaden the labor market alternatives of low-skilled individuals. And the reason for looking at self-employment is that this is something that is quite frequently looked at as a route to upward economic mobility, and in order to kind of get some information on this is something that we should encourage, we're going to look at the degree of success that is realized by those choosing self-employment. And so we are going to look at what kind of earning expectations are realistic for low-skilled workers, and how do they compare to those of similar workers in wage-salary employment.

Moderator: Are there any particular challenges faced in addressing your research question?

Lofstrom: One [challenge] worth pointing out here is the difficulty in comparing the earnings of business owners to the earnings of those working in wage-salary employment. It's kind of like comparing apples and oranges. And, here, the issue is that self-employment earnings, they may very well reflect the returns to financial capital that's been invested in the business while the earnings of wage-salary workers clearly doesn't reflect that. Fortunately for us, the data that we are using here, the survey of incoming program participation, allows us to address this issue, and so we can discount the reported earnings by business owners by a proportion of their reported business equity and thereby create measures that are comparable between the self-employed and individuals who are working in wage-salary work.

Moderator: Your paper looks at some recent trends in self-employment. What are some of the important changes you've observed over the last few decades?

Lofstrom: Some of the more striking trends that are relevant to this paper, they showed the increased importance of woman and immigrants. And just to give you a few examples, for example, women…represented about 24 percent of business owners in 1980, and today that figure is about 36 percent, so that is a pretty impressive growth. Immigrants play a very important role, and about one-third of the growth in self-employment between 1980 and 2007—which is the most recent date that we have data for—is due to immigrants. And today, about 18 percent of business owners are foreign-born, which is up from less than 7 percent in 1980. So compared to what immigrants share in overall workforces, this means that they are overrepresented there, about 16 percent in the overall workforce. Maybe the most striking trend is that all the net growth that we observe in low-skilled self-employment comes from immigration.

Moderator: Your paper analyzes earnings of self-employed low-skilled workers and compares them to those of their salaried counterparts. What did your findings reveal?

Lofstrom: Well, the findings reveal a somewhat somber picture of low-skilled self-employment, and although top-earning entrepreneurs have higher earnings than top-earning wage-salary workers, the earnings of most low-skilled workers is higher in wage-salary employment than it is in self-employment. The results also point to different economic returns to self-employment among low-skilled men and women, and also between U.S.- and foreign-born workers.

Just to give you a few examples of some of the findings that highlight this: we do see evidence of faster earnings growth among self-employed men, and, in fact, the results suggest that low-skilled self-employed men may partially overcome their lower earnings over time—that is, looking over time as measured by age or the number of years in business. And, for example, among immigrant men, there is some evidence that they might possibly catch up with the earnings of low-skilled wage-salary workers after about 15-plus years in business.

The results also point to some lower returns among low-skilled women when we compared them to men, and it suggests that the financial rewards for self-employment are particularly low among native-born low-skilled women. When we look at earnings growth, we don't find any evidence of earnings catch-up, either for U.S.-born or foreign-born female low-skilled immigrants. But we do observe some pretty strong relative growth among native-born low-skilled women, but they start at a substantially lower earnings, so they do not appear to reach earnings parity.

Moderator: On average, what do these self-employed low-skilled workers earn in a year?

Lofstrom: Focusing on the low-skilled self-employed, we see, for example, that the average earning among U.S.-born men is about $38,000. It's about $33,000 for foreign-born men. It's substantially lower for women. Among U.S.-born female low-skilled entrepreneurs, it's only about $21,000, and for foreign-born low-skilled female entrepreneurs, the average earnings is only about $21,400—so roughly the same as it for low-skilled native-born female entrepreneurs.

Moderator: What are the policy implications of your paper's findings on the effects of self-employment on the well-being of low-skilled workers, and is there a role for economic developers?

Lofstrom: It's pretty clear that there is no strong evidence indicating that business ownership increases the economic well-being of most low-skilled workers. And I think what this means is that it really does not provide strong support for any further policy interventions that directly encourage low-skilled workers to start their own businesses. So if our objective is to improve the economic well-being of disadvantaged groups, a focus on increasing skills is really the one that is most likely to lead to more lasting improved economic outcomes. Some examples of policy goals, or policies that might achieve this, would be to encourage further enrollment in colleges, community colleges. This could be in terms of career technical training or vocational training. A large proportion of the group that we are talking about here are foreign-born, so English language courses are another possible policy target here to improve their outcomes as well.

Moderator: Dr. Lofstrom, thank you for joining us today.

Lofstrom: Well, thank you. It's been a pleasure speaking to you today here, Alicia.

Moderator: This concludes our podcast. We've been speaking with Dr. Magnus Lofstrom, research fellow at the Public Policy Institute of California. For more podcasts on this topic and others, visit the Atlanta Fed's website at www.frbatlanta.org. If you have comments or questions, please email podcast@frbatlanta.org.

Thanks for listening.