Informality, self-employment and heterogeneous managerial ability: A model for developing countries

The view of informal employment as a last resort in the labour market has recently been challenged by numerous studies documenting the existence of a high degree of heterogeneity within the formal and informal sectors. In particular, informal self‐employment/employment may be voluntary or forced. There is currently not much theoretical support for these observations. We develop a theoretical model of the labour market with both formal and informal firms and a distribution of managerial skills in the population. Consistent with existing empirical evidence, this setup reconciles the undesirable and productive forms of self‐employment that coexist in the economy.