Informality, workers' compensation and labor market welfare

Abstract

Informality is extremely important in labor markets in developing countries. In Brasil, half of the labor force is in the informal sector. This generally includes unregistered employees and the self employed who do not contribute to pensions. The informal sector gained importance in academia and policy research because it is considered an obstacle to growth and to efficiency in labor markets of developing countries. Informal workers are found in low productivity jobs, thus are less likely to develop skills or to generate employment in the self employment case. Moreover, these workers are not entitled to benefits or protection guaranteed by labor laws. On the other hand, informality allows firms, especially the least productive, to operate where legal minimum wage and taxes do not apply, thus is an important source of employment.Several researches seeking to understand the wage gap between the formal and informal sectors have assumed market segmentation. In this context, vacancies in the formal sector are scarce and workers queue for a formal sector job while the informal sector forms a subsistence sector, a buffer against unemployment. More recently, the literature has challenged this view based on evidence of preferences for certain attributes in the informal sector and given a significant mobility between these two sectors, in either direction. Evidence like this has guided recent papers about employment and earnings in the developing world to understand or to consider the coexistence of two sectors in the labor market. In particular, these papers relax the hypothesis of extreme segmentation and allow individual's choice about which sector to work, given a number of facts such as the workers total compensation and the firm cost structure to hire a worker. This project aims to contribute to the recent literature by (i) offering a more flexible approach to understand the formal and informal sectors. It proposes more parsimonious models that can be estimated with available data and the use of these models to simulate the impact of labor market policies that vary the cost of formal employment or enforcement of labor regulations, (ii) alternatively, it proposes an empirical test of these models' predictions using data about employment, wages and several job benefits that are observed in microdata. At last, this project is to (iii) understand the worker's compensation structure in both sectors, taking into account the types of contracts, arrangements and pay in each sector, and how these influence the workers' compensation during economic downturns. (AU)