labor informality

1

Labor Informality

Bill MaloneyLCRCE

www.worldbank.org/laceconomistwww.worldbank.org/wmaloney

2

Informality is a poor country issue, no matter how it is measured.

0

10

20

30

40

50

60

70

80

90

100

- 10,000 20,000 30,000 40,000

Latin America Advanced Countries Rest of the world

Lac

k of

Pen

sions

(% L

abor

For

ce) 1

/

2005 GDP per capita PPP adjusted

2 Measures of Informality vs Income per Capita

0

10

20

30

40

50

60

- 10,000 20,000 30,000 40,000


Self

Em

ploy

men

t (%

of L

abor

For

ce) 2

/


Def: Legal/Social Protection Def: Productive

wb17920

LA not especially high, although rising trend in some countries in the 1990s.

3

Why do we care? Unprotected workers: issue of welfare, equity and

efficiency Productivity: firms too small? Barriers to growth? Indicator of regulatory distortions Low and distorted tax collections and poor provision

of public services Weak rule of law and Governance: A problem in our

social contract?

4

Exit and Exclusion Traditional exclusion view of informality

Labor: inferior jobs in a segmented market Firms: denied access to services by high entry costs (de Soto)

Exit view: agents analyze costs vs. benefits of becoming formal Labor: informality offers flexibility, avoidance of poorly designed

benefits programs, and provides “decent” work Firms: don’t need/want State programs, don’t pay for them Larger firms and individuals: Why pay taxes if can avoid?

Both exist to varying degrees across countries but have different implications for policy

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The Informal WorkerComparative Advantage and Constraints

6

3 margins of informalityMargins of Informality

0

5

10

15

20

25

30

35

Firm Size - workers (q)

Sh

are

of

lab

or

forc

e

Formal Informal

Intersectoral Margin (firms) DeSoto

Modern FirmsMicro Firms

Intersectoral Margin (labor)

Intersectoral Margin (labor)

Intrafirm Margin

Maloney 2006)

8

Intrafirm Margin-not central story Most informal workers found in small firms

The allocation of Informal Workers across firm size

75% of Mexican and Argentine in firms of at most 5 workers However, expansion in large firms in Arg, Bra over 1990s

0

5

10

15

20

25

30

35

40

45

50

1 2-5 6-10 11-15 16-50 51-100 101-250 250 +

1994

2004

Mexico(Urban Areas)

% o

f Inf

orm

al a

nd S

elf E

mpl

oyed

wor

kers

Firm Size

0

5

10

15

20

25

30

35

40

45

50

1 2 to 5 6 to 25 26 to 100 101 to 500 501 +

1980

2003

Argentina (Gran Buenos Aires)

% o

f Inf

orm

al a

nd S

elf E

mpl

oyed

wor

kers

Firm Size

9

Intersectoral (de Soto) Margin (firms) -How many are close to becoming formal? Firm size determined by cost structure (Lucas 1978)- many

may not be close to margin MX: “Reason for not registering” (Woodruff and McKenzie

2006) 75% “business is too small” ~10%- cost of registration, compliance too high

Fajnzylber et al (2006): little “dynamism” in small firms MX: lowering of registration/compliance costs leads to small

and temporary change in registration- .2% of stock of informal. (Kaplan et. al 2006)

BR: Fajnzylber et al (2007) small reaction to SIMPLES program.

Evidence to date suggests that this is not the critical margin.

10

Intersectoral (worker) margin: Competing theories Disadvantaged group of a segmented labor market

Formal: Protected sector/High productivity/Good jobs Informal : Disguised Unemployment/Low productivity Queuing to get job in the formal sector, worse in downturns.

Alternate view here: workers choose among differing job characteristics (Lucas again) Unregulated largely voluntarily microfirm sector. Entrepreneurs weigh pros and cons of formality Firms may have little potential for growth Similar to job-job transitions in US

Conditional wage comparisons are faux amis: Need to look at other indicators, in particular, labor flows

11

Two Distinct Types of Informal Worker

Distribution of informal workers in Latin America

% contributing to social security system

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

Chi

le 2

003

Uru

guay

200

4

Bra

zil 2

003

Arg

enti

na 2

005

El S

alva

dor 2

003

Ven

ezue

la 2

003

Mex

ico

2002

Dom

. Rep

ubli

c 20

06

Gua

tem

ala

2002

Col

ombi

a 20

06

Nic

arag

ua 2

001

Ecu

ador

199

8

Bol

ivia

200

5

Peru

200

2

% e

mpl

oyed

wor

kers

Informal Salaried Informal independent

% Not Contributing to Social Security System

12

05

1015

2025

3035

4045

50

15 19 23 27 31 35 39 43 47 51 55 59 63 67

Self-Employed Form Informal

Role of Each Changes across Life-Cycle Informal Salaried

port of entry for youth accumulate experience

for Formal Salaried or independent work

Most in micro firms

Self Employment prevalent among prime

or older have capital and skills

to open a business

Mexico: Employment as share of age cohort

Cunningham (2007)

13

Microfirm Dynamics:Similar to mainstream firms

Mexico

0

10

20

30

40

50

60

18-20 21-25 26-30 31-35 36-40 41-45 46-50 51-55 56-60 61-65

Age

Per

ce

nt

Entry Rate Exit Rate Self-employment Rate

0

10

20

30

40

50

60

18-20 21-25 26-30 31-35 36-40 41-45 46-50 51-55 56-60 61-65

Age

Per

cen

t

Entry Rate Exit Rate Self-employment Rate

United States MEXICO UNITED STATES

Firm Entry, Exit, Participation by Age

SE Rate

Exit Rate

Entry RateSE Rate

Exit Rate

Entry Rate

Age Age

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Workers tell us of both exit and exclusion Most (~2/3) of independent

workers are voluntary not queuing for formal

jobs value flexibility, esp. women opting out of Social Protection

Most Informal Salaried are involuntary would prefer to be FS or SE Exceptions Dominican Republic,

Mexico youth: difficulty entering

workforce

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

od

ds

ra

tio

Independent InformalSalaried

Argentina Dominican Republic

Self-rated Poverty Relative to Formal Workers

Source: (Arias 2007)

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Labor Dynamics- The New Frontier

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Mainstream debate on Gross Worker Flows across the cycle Implications for role of informality Nature of the adjustment process

Blanchard and Diamond (1990) Increase in unemployment was due to the increase in the number

of people entering the unemployment pool. Davis and Haltiwanger (1990, 1992) highlight the

importance of job destruction in recessions Stylized fact drives modern models of search such as Mortensen

Pissarides (1994). Shimer (2005) differs: Acyclical separation rates;

Procyclical job finding rate

17

Data: Rotating Panels Mexico 1987-2002, ENEU (Urban Employment Survey)

16 major cities in Mexico Brazil: 1980-2002, PME (Monthly Employment survey)

5 large metropolitan areas Permit following workers across:

Formal, Salaried, Informal Salaried and Informal Self employed sectors

Unemployment and inactivity Following Geweke (1986) map discrete transitions

probabilities to continuous time model.

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Worker transitions often suggest voluntary entry

.08

.1.1

2.1

4.1

6.1

8S

elf-

Em

ploy

ed

to F

orm

al

.03

.04

.05

.06

.07

For

ma

l to

Se

lf-E

mpl

oym

ent

1987q1 1991q1 1995q1 1999q1 2003q1

Formal to Self-Employment Self-Employed to Formal

Mexico

Self Employment to Formal Salaried

Formal Salaried to Self Employment

Source: Bosch and Maloney (2008)

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And perhaps exclusion after reforms in Brazil

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45

Sel

f-E

mpl

oym

ent

to F

orm

al

.81

1.2

1.4

1.6

1.8

For

mal

to

Sel

f-E

mpl

oym

ent

1983m1 1988m1 1993m1 1998m1 2003m1time...

Formal to Self-Employment Self-Employment to Formal

Brasil

SE to Formal

Formal to SE

Constitutional and Commercial Reforms

Bosch, Goñi, Maloney (2007)

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The Role of Informality in the Adjustment Process Modern literature focuses on dynamics

“Stock” of unemployment, informality a function of job finding and separation rates

US literature- Volatility of job finding rate across cycle higher than of

separation rate. So movement in unemployment due to less hiring, rather than

more firing (Shimer)

ft

st

st

tqq

qu

*

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Job separations: IS most volatileMexico Brazil

0.0

5.1

.15

1987q1 1991q1 1995q1 1999q1 2003q1

S-U I-UF-U

0

.02

.04

.06

.08

.1

1983q1 1988q1 1993q1 1998q1 2003q1

S-U I-UF-U

Formal job separations similar to the US. (Countercyclical, low volatility) Job separation in the informal salaried sector is much higher than in the

formal sector, and jump more in downturns. In MX: U driven by IS separations!


IS IS

SE SEFS

FS

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Job Finding Rates: FS most volatile

Job Finding in the formal sector is high volatility and highly pro-cyclical similar to the US.

Job finding rates in the Informal sectors are reasonably constant.

Mexico Brazil

.1.2

.3.4

.5.6

1987q1 1991q1 1995q1 1999q1 2003q1

U-S U-IU-F

0.1

.2.3

.41983q1 1988q1 1993q1 1998q1 2003q1

U-S U-IU-F

IS

FS

SE

IS

FS

SE


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Updated view of cyclical adjustments of LDC labor markets

Volatile Formal JF + Constant Informal JF means informal often expands in downturns.

But, why do JF patterns differ across sectors? Exactly analogous to US debate. Shimer (2005):standard search models cannot explain

the magnitude of the fluctuations in job finding rate. Efforts to fix models

Shimer: extreme wage rigidity? Mortensen and Nagypal (2005):maybe not-information

assymetries etc.

24

Why is informality sometimes “Procyclical”

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.41

987

19

88

19

89

19

90

199

1

199

2

199

3

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94

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95

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96

199

7

199

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199

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00

20

01

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02

200

3

200

4

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

Unconditioned Earnings F/SE Real exchange rate Formal/SE

Mexico

Rel

ativ

e ea

rnin

gs

Rea

l ex

chan

ge

rate

For

mal

/ S

E

Procyclical/Integrated Countercyclical/Segmented

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Why is informality sometimes “Procyclical”

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

1 .0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

Unconditioned Earnings F/SE Real exchange rate Formal/SE

Colombia

Rel

ativ

e ea

rnin

gsR

eal e

xcha

nge

rate

For

mal

/ SE

Procyclical/Integrated Countercyclical/Segmented

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Implications Shows net voluntary entry Modeling (Fiess, Fugazza, Maloney (2007)

Depend on positive shocks To Formal/Tradable To Informal/Nontradable

FS rigidities less binding in booms

Increase in Informality in early 1990s Boom in nontradables: REER appreciation due to boom in capital inflows: opening of Capital account, Exchange Rate Based Stabilization,

improved expectations due to reforms

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What drives longer term behavior?

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Why does it decrease with development?

0

10

20

30

40

50

60

70

80

90

100

- 10,000 20,000 30,000 40,000


Lac

k of

Pen

sions

(% L

abor

For

ce) 1

/


2 Measures of Informality vs Income per Capita

0

10

20

30

40

50

60

- 10,000 20,000 30,000 40,000


Self

Em

ploy

men

t (%

of L

abor

For

ce) 2

/


Def: Legal/Social Protection Def: Productive

wb17920

LA not especially high, although rising trend in some countries in the 1990s.

29

But nature of regulation matters too Bad quality services and protections- why

bother being formal But regulation matters too

Loayza et al (2006) poor gov’t and heavy regulation increase size

30

Brazil’s increase? Constitutional change or trade reforms?

Dynamic Panel: 18 Industries, Yearly 1983-2002

Trade Liberalization:

Import Penetration: Muendler (2002) Real effective trade protection rates: Kume et al. (2003)

Constitutional Changes:

Firing Costs: average tenure (in years) of workers fired (average 1983-1987, source: PME) Overtime: proportion of workers working more than 44 hours (average 1983-1987, source:

PME) Union density: % of unionized workers (average 1986 and 1988, source: PNAD)

jtCCDjTRADEjttjjt uCCDTRADEY .*

31

Constitutional change or trade reforms? Regression analysis

Variable Sector Size Industry Differentials Creation Destruction

Dependent (-1) 0.64 *** 0.46 *** 0.07 0.0710.06 0.05 0.07 0.054

Dependent (-2) 0.17 *** 0.18 *** 0.29 *** 0.0530.04 0.05 0.06 0.050

Effective Tariff -1.08 0.03 0.28 * -0.0032.02 0.09 0.16 0.004

Import Penetration -8.17 ** -0.31 *** -0.43 *** -0.0053.19 0.10 0.15 0.005

Tenure 0.44 *** 0.02 * 0.24 *** 0.0000.12 0.01 0.04 0.001

Tenure (-1) -0.24 -0.05 *** -0.32 *** 0.0000.16 0.01 0.02 0.000

Overtime 3.21 *** 0.23 *** -0.78 *** 0.0010.99 0.04 0.04 0.003

Overtime (-1) -5.56 *** -0.29 *** 0.65 *** -0.006 ***1.38 0.06 0.06 0.002

Union 0.21 0.11 -0.56 *** 0.018 ***1.24 0.10 0.16 0.003

Union (-1) 3.07 ** -0.14 * 0.51 *** -0.016 ***1.52 0.07 0.08 0.002

C 14.80 *** 1.53 *** 0.49 *** 0.012 ***3.91 0.26 0.07 0.003

R2 (Weighted) 0.997 0.998 0.765 0.810R2 (Unweighted) 0.986 0.964 0.736 0.378Durbin Watson 2.08 2.06 2.10 2.03Included observations 18 18 18 18Cross-section included 18 18 18 18Total pool observations 324 324 324 324

32

Actual and predicted size of the formal sector in Brazil

65

70

75

80

85

90

19

83

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84

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85

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99

20

00

20

01

20

02

Actual No trade No Constitution

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Policies to Reduce Informality Reduce opportunity cost of informality: raise productivity in

the formal sector improved Investment Climate higher human capital accumulation

Remove segmenting distortions in labor markets where applicable

Tilt the benefit/cost ratio of firms and workers to opt for formality: removing distortionary incentives in Social Protection Systems, reducing cost of doing business for all firms improving services associated with formality especially for SME’s,

Improve quality and fairness of institutions and policies and even handed enforcement: move social norms towards a culture of compliance. A potential virtuous circle

labor informality

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