Unemployment, self-employment, and labour market functioning in Ethiopia

Two aspects of developing country labour markets receiving a lot of attention, in particular in Ethiopia, are unemployment and small-scale or “necessity” entrepreneurship. In urban Ethiopia for instance, youth unemployment rates lie around 15%, and the self-employment rate reaches almost 40% (2011 Urban Employment Unemployment Survey). While this indicates a clear need for improving labour market functioning and related policies, there is no agreement on which labour market features cause these outcomes. However, knowing the nature of frictions is key for determining their welfare effect and for evaluating the effects of policies intended to reduce unemployment or help the unemployed.

The aim of this project therefore is to:

1. Develop a general equilibrium model suitable for the quantitative analysis of labour markets with substantial rates of unemployment and entrepreneurship, and to

2. Use this model to study the importance of several potential frictions in the Ethiopian labour market.

In Ethiopia, high rates of entrepreneurship go along with a large number of very small firms (often own-account workers) with low productivity and profits. Their existence indicates that their owners either face low potential wages in employment, or have difficulty accessing jobs. Labour market frictions and any factors affecting labour demand by large firms thus are key determinants of both necessity entrepreneurship and unemployment.

There are several relevant barriers to job-finding. First, research on unemployment in industrialised economies has focused on informational frictions. The relevance of such frictions in the Ethiopian context is unexplored. Second, firms may use wages as motivational tools or for screening. As a result, some job seekers may be rationed out of employment. Finally, job seekers (in particular young ones) may have aspirations that are not in line with available jobs. What drives unemployment — frictions, firm behaviour, or search behaviour — matters for welfare consequences of unemployment and for policy effectiveness.

The core of the project therefore consists in theoretically evaluating the effects of different types of frictions, using simulations of a quantitative model of unemployment and entrepreneurship. This will give a first indication as to which underlying driver of unemployment is important in the Ethiopian context, and will also help to identify what additional data could be used to determine this more precisely. In future work, the model could then be extended and used for policy analysis.