This paper studies the effects of foreign competition on self-employment levels. We begin by pointing out a previously unknown fact: the greater the exposure to foreign competition, the smaller the fraction of self-employed people. This fact holds across very different countries, across relatively similar countries like European Union members, and across industries within the United States. We develop a model where heterogeneous agents select themselves into being either employees or self-employed in the spirit of Lucas (1978). This, in turn, translates into intra-industry firm heterogeneity as in Melitz (2003). Self-employed agents (firms) can also decide to enter into the export markets, subject to fixed and variable trade costs. The model delivers three basic predictions: (1) domestic self-employment increases with the trade costs of exporting from a foreign country to the home country, (2) domestic self-employment increases with the trade costs of exporting to the foreign country, and (3) higher levels of self-employment are associated with a lower fraction of exporting firms. Our empirical work on inter-industry data for the United States confirms these predictions of the model.
JEL Classifications: F12, F16, J23
Keywords: self-employment, tariffs, international trade