Buffering Recessions: Self-Employment’s Role in EMDE Labor Market Stability

The study finds that self-employment in EMDEs acts as a buffer during recessions, making their labor markets less sensitive to GDP shocks than those in advanced economies. However, this resilience comes at the cost of informality, lower job quality, and limited social protections.

A new study from the World Bank’s Development Economics Prospects Group, in collaboration with Johns Hopkins University, presents groundbreaking insights into how labor markets in advanced economies and emerging markets, and developing economies (EMDEs) respond differently to economic shocks. The research, authored by Prakash Loungani (Johns Hopkins University), Emiliano Luttini, and Hayley Pallan (World Bank), analyzes nearly three decades of data from 28 advanced economies and 30 EMDEs. At the heart of their findings is a striking revelation: EMDEs, despite more violent GDP cycles, tend to suffer less severe employment losses during recessions, largely due to a higher share of self-employment.

Self-Employment: A Hidden Shock Absorber

The study challenges traditional economic expectations that greater output volatility should correspond with more intense labor market disruptions. In advanced economies, labor markets are more tightly coupled with GDP movements, employment falls rapidly when output declines, and recovers slowly. In EMDEs, however, the labor market response is more subdued, even though GDP may fall more sharply. This paradox is largely explained by employment composition: EMDEs have significantly higher shares of self-employment, which tends to be less sensitive to business cycles than wage-based jobs.

The authors estimate that in the short term, employment composition explains about 70 percent of the difference in labor market sensitivity between the two groups, while in the medium term (over three years), it still accounts for 40 percent. The stability of self-employment during recessions provides a cushion against widespread job losses, helping EMDEs maintain relatively steady employment levels even in the face of deep economic contractions.

Wage Jobs Plunge, Self-Employment Holds Steady

Wage employment in advanced economies shows a distinct “easy-to-fall, hard-to-rise” pattern. Jobs are lost quickly during downturns and return slowly, resulting in prolonged labor market recoveries. In contrast, EMDEs show more symmetric wage employment cycles and a surprising resilience in self-employment, which often increases during downturns. This dynamic helps explain why overall employment in EMDEs contracts less during recessions.

The study quantifies this difference using Okun’s Law, which links changes in unemployment and employment to GDP growth. In advanced economies, a one percentage point drop in GDP results in a 0.5 percentage point decline in employment and a 0.4 percentage point rise in unemployment. In EMDEs, the same GDP decline corresponds to only a 0.2 point drop in employment and a 0.1 point rise in unemployment. This clear divergence underscores the protective effect of self-employment in developing economies.

The COVID-19 Recession: A Stress Test for Informality

While the buffering role of self-employment generally holds, the COVID-19 pandemic presented an exception. During the 2020–2021 global recession, EMDEs experienced sharp declines not only in wage employment but also in self-employment. The dual collapse marked a break from historical patterns and exposed the vulnerability of informal work arrangements to extreme, non-traditional shocks. Unlike previous financial or non-financial recessions, where self-employment in EMDEs either held steady or expanded, the pandemic disrupted informal sectors with devastating force.

This collapse undermined the usual resilience of EMDE labor markets, leading to steeper employment declines than in some advanced economies. The episode highlighted a key vulnerability: while informal employment can act as a short-term stabilizer, it is highly susceptible to shocks that prevent face-to-face work, limit mobility, or cut off access to local markets.

Demographics Matter: Youth and Low-Education Workers Hit Hardest

Beyond broad national differences, the study reveals significant demographic variations in labor market responses. Across both advanced economies and EMDEs, young workers (ages 15–24) and those with only basic education are the most affected by economic downturns. However, the damage is consistently more severe in advanced economies. Youth employment in these countries falls by over 6 percentage points during recessions, compared to around 2 points in EMDEs.

Self-employment again plays a buffering role in developing countries, especially for workers with limited formal education. In EMDEs, many less-educated individuals are absorbed into informal or self-employment during downturns, mitigating overall job losses. But while this helps soften the blow in the short term, it does little to address the deeper issues of low job quality and productivity in the long run.

Policy Trade-Offs: Flexibility vs. Formalization

The findings carry major policy implications. For EMDEs, the short-term advantage of self-employment as a stabilizer must be balanced against the need to transition toward more productive, formal employment. Informality often comes with weak social protections, limited access to capital, and fewer opportunities for upward mobility. Policymakers in these economies must therefore pursue reforms that preserve flexibility while improving job quality. Expanding social safety nets, investing in education and skills, and reducing barriers to formal employment are critical steps.

For advanced economies, the research points to the need for better labor market tools to manage cyclical downturns. Job retention schemes, active labor market policies, and support for re-skilling could help soften employment contractions and speed up recoveries. While these countries have more developed institutions, they also face higher labor market rigidity, which can amplify the negative effects of recessions.

In essence, the study reframes self-employment not just as a symptom of informality but as a functional—albeit imperfect—shock absorber in EMDEs. It calls attention to the complex trade-offs between stability and quality, flexibility and formality. As economies around the world grapple with post-pandemic recovery and increasing macroeconomic uncertainty, understanding these dynamics is more critical than ever.