Abstract
This paper shows that local labor market power provides a rationale for the higher prevalence of self-employment in developing economies relative to developed economies. Labor market power creates occupational mismatch–too many workers choose self-employment relative to the competitive benchmark. Because of labor market power, workers underinvest in skills that increase paid employment productivity and overinvest in those that enhance self-employment productivity. Under certain conditions, this exacerbates the occupational mismatch. We also consider a quantity-type product market competition model where self-employed individuals form a competitive fringe. Product-market competition increases the intensity of competition for workers and reduces occupational mismatch.