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Informality: What it is, What to do about it?. Carmen Pagés & Stefano Scarpetta The World Bank December , 2004. The WB work on the labor market research strategy . Poor labor market outcomes in many countries: unemployment, under-employment, exclusion

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informality what it is what to do about it

Informality:What it is, What to do about it?

Carmen Pagés &

Stefano Scarpetta

The World Bank

December , 2004

the wb work on the labor market research strategy
The WB work on the labor market research strategy
  • Poor labor market outcomes in many countries: unemployment, under-employment, exclusion
  • Over the past two years we have launched a thorough analysis of the functioning of LM and policy challenges
  • Regional stock taking papers prepared and discussed in November 2004
  • In all of these regional papers, informality has emerged as one of the key policy issues
informality is persistent even in countries with sustained growth
Informality is persistent even in countries with sustained growth
  • How do we measure informality?
    • Great heterogeneity within most informal economies
  • What drives drive/cause the different “types” of informality?
    • Exclusion vs choice,
    • … also related to regulations in product and labor markets
  • Need to understand the consequences of informality on individuals and the economy
  • Can we design social protection schemes for those excluded from the formal sector?
this pr esentation
This presentation:
  • What is informality?
  • Theories of informality
  • Recent empirical evidence
  • New evidence based on social security coverage in LAC
  • Extending evidence to other regions
first problem what is informal employment
First problem: What is informal employment?
  • Multiple definitions, only some overlap:
      • Self-employed and workers in household enterprises (<5 w)
      • Workers without formal contract
      • Workers without access to social protection and other mandated benefits
      • Workers employed in registered firms
  • Cross-country data is not comparable
  • New forms of informality?: Part-Time, Temporary, fixed-term contracts.
what causes informality
What causes informality?

Two groups of (not necessarily competing) theories:

  • Exclusion
  • Choice
what causes informality1
What causes informality?
  • Exclusion: Wage rigidities prevent market clearing. In economies without UI, workers resort to informal jobs to survive

 Informal jobs are worse type of Jobs.

Harris-Todaro (1970); Fields (1972)

wh at causes informality
What causesInformality?
  • Choice:
    • Firms: Costly regulations push firms to become informal  Firms may do better, but informal sector jobs are bad. Productivity costs for firms who want to remain inconspicuous.
    • Workers: Workers move voluntarily to informal jobs to improve their lot (less taxes, more independency and flexibility)

Maloney (1999)

what is the empirical evidence
What is the empirical evidence?
  • Traditionally, empirical evidence on informal employment focused on testing for wage differentials.
  • But many problems in this estimation due to self-selection issues
  • Maloney 1999 convincingly argues against wage differentials as valid evidence  wage differentials do not measure welfare differentials.
recent empirical evidence for lac does not fit with exclusion hypoth
Recent empirical evidence for LAC does not fit with exclusion hypoth.
  • There is high mobility between formal and informal jobs

Maloney (99, 05), IADB (03) ARG, MEX, BRA

  • For Mexico, some evidence suggestssegmentation for skilled but not for unskilled labor

Gong X. and A. van Soest (02, 04)

  • For Mexico, flows from F to I and from I to F decline in recession/increase in expansionary times. Transitions during recessions were to U not to I.

Bosh and Maloney (05)

recent empirical evidence for lac does not fit with exclusion hypoth1
Recent empirical evidence for LAC does not fit with exclusion hypoth.
  • Minimum wages are equally or more binding in informal than in formal sector. Maloney and Nuñez (2004)
  • Wages decline with social security tax increases; wages are lower in jobs that provide access to social security.

Marrufo (2004)[Mexico] Gruber (1997) [Chile] and Edwards and Edwards (2002) [Chile], Mondino and Montoya (2004) [Argentina]

in summary
In summary:
  • Some evidence of segmentation (for high skilled workers), but much evidence does not fit with simple theory that workers move to informal jobs to eke a living
  • Evidence only available for a few Latin American countries, need to come up with evidence from other regions/countries
new evidence based on ss coverage in lac
New evidence based on SS coverage in LAC

Proportion of workers contributing to social security

LAC Household Surveys

new evidence based on ss coverage in lac1
New evidence based on SS coverage in LAC
  • We examine what explains the patterns of coverage at the individual level for a sample of 11 LAC countries using micro data.
  • Want to understand why so few people participate. Is it that:
      • They choose not to participate? (they don’t value the protection offered by SS, i.e. costs>benefits, or they are myopic)
      • They are rationed because they could not find a good job with benefits?
new evidence based on ss coverage in lac2
New evidence based on SS coverage in LAC
  • Whether is Exclusion or Choice has important implications for policy design:
      • Exclusion: Basing social protection provision on labor market participation limits access. Need to delink social security provision from labor market.
      • Choice: System is poorly designed. Systems need to be amended to attract more participants
      • Choice: People are myopic. Need to improve enforcement.

Public discussion emphasizes 1 in developing countries and 3 in more developed ones.

in all countries less advantaged workers are less likely to participate in ss exclusion
In all countries less advantaged workers are less likely to participate in SS. Exclusion?
  • Individual and household characteristics account for more than 30 percent of explained variance in SS participation.
  • Yet, coefficients in a Probit need to be interpreted carefully, for instance:
      • Importance of individual characteristics like education may just reflect high correlation between education and some job unobservables (i.e. having a formal contract)
      • From a Probit alone is difficult to infer Choice or Exclusion.
less advantaged salaried workers are less likely to participate in ss exclusion
Less advantaged salaried workers are less likely to participate in SS. Exclusion?
  • We compare the choices of the self-employed for whom participation is voluntary and unrestricted by employers with the choices of salaried employees (compulsory).
  • We find contribution patterns of self-employed to be highly similar to the ones of salaried workers. Correlation above .7 (1%) in all countries examined.

We interpret these findings as evidence that there is an important component of CHOICE

less advantaged workers are less likely to participate in ss exclusion
…Less advantaged workers are less likely to participate in SS. Exclusion?
  • But also evidence suggests exclusion for some workers:
      • Salaried Workers with earnings below the minimum wage
      • Salaried Workers in part-time jobs

Externalities among different forms of evasion, evading on MW leads to evasion in SS;

Also, part-time work seems to be an instrument of evasion

implications of new evidence based on ss coverage
Implications of new evidence based on SS coverage
  • Evidence of both choice and exclusion.
  • Need to learn more on whether individuals/households are myopic, or rather find alternative (and better) ways to protect themselves against risks
  • Need to consider effect of MW on informality.
  • Need to make part-time work less prone to evasion.
implications of new evidence based on ss coverage1
Implications of new evidence based on SS coverage
  • If people opt out because they the current system don’t satisfy their needs, Increasing enforcement may reduce welfare and employment.
  • If people opt out because they are myopic, more enforcement may increase welfare & formality, but at the cost of lower employment.
  • Given low capacity to enforce, social security programs may need to be more self-enforceable.
ongoing project
Ongoing project—
  • Seeks to analyze whether results found for some countries in LAC generalize to other countries in ECA and also LAC
  • Seeks to understand what drives cross country differences:
    • Differences in levels of informality: High in LAC, low in ECA.
    • Differences in mobility and wage differential patterns
  • Seeks to identify who are the vulnerable workers in the labor market and which policies can better help them.
ongoing project1
Ongoing project
  • It follows recent literature:
    • Examines mobility patterns: Computing transition matrices, estimating multinomial dynamic logits
    • Examines wage, consumption and welfare differentials across transitions: Estimating wage change models.
  • Focuses on countries for which panel data exists
issues for discussion
Issues for discussion:
  • What drives drive/cause the different “types” of informality?
    • Exclusion vs choice,
    • … related to regulations in product and labor markets
  • Need to understand the consequences of informality on individuals and the economy
  • What are the most promising avenues of research?
  • Can we design social protection schemes with a wider reach?