Does Self‐employment Pay? The Role of Unemployment and Earnings Risk

This paper documents the role of unemployment and earnings risk in reconciling evidence in payoff differentials between self‐employment and paid‐employment. Using Spanish administrative data, we characterize the distribution and dynamics of earnings and document lower and less dispersed earnings in self‐employment. We consider alternative hypotheses and highlight the role of lower unemployment risk in self‐employment. We decompose earnings risk dynamics by estimating a life‐cycle earnings process. Indeed, the self‐employed experience lower returns but also face lower volatility and persistence of shocks throughout their life‐cycle. Our results challenge the conventional view that self‐employment necessarily entails higher risk and highlight that accounting for differences in labour earnings risk is important to reconcile the payoff differentials between self‐employment and paid‐employment.