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Contractual Dualism, Market Power and Informality

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  • Basu, Arnab K
  • Chau, Nancy H
  • Kanbur, Ravi

Abstract

Two stylized representations are often found in the academic and policy literature on informality and formality in developing countries. The first is that the informal (or unregulated) sector is more competitive than the formal (or regulated) sector. The second is that contract enforcement is easier in the formal sector than in the informal sector, precisely because the formal sector comes under the purview of state regulation. The basic contention of this paper is that these two representations are not compatible with each other. We develop a search-theoretic model of contractual dualism in the labor market where the inability to commit to contracts in the informal sector leads to employer market power in equilibrium, while an enforced minimum wage in the formal sector provides employers with a commitment technology but which reduces their market power in equilibrium. The contributions of this paper are three-fold. It (i) provides the micro-underpinnings for endogenous determination of employer market power in the formal and informal sectors due to contractual dualism in the two sectors, (ii) offers a unified and coherent setup whereby a host of salient features of developing country labor markets can be explained together, and (iii) places the original Stiglerian prescription of the optimal (unemployment minimizing) minimum wage in the broader context of labor markets where formal job creation is costly, and where formal employment, informal employment, and unemployment co-exist.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8485.

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Date of creation: Jul 2011
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Handle: RePEc:cpr:ceprdp:8485

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Keywords: Contractual Dualism; Employer Market Power; Informality; Wage Dualism;

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References

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  1. James Albrecht & Lucas Navarro & Susan Vroman, 2006. "The Effects of Labor Market Policies in an Economy with an Informal Sector," Working Papers gueconwpa~06-06-06, Georgetown University, Department of Economics.
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  8. Gindling, T.H. & Terrell, Katherine, 2007. "The effects of multiple minimum wages throughout the labor market: The case of Costa Rica," Labour Economics, Elsevier, vol. 14(3), pages 485-511, June.
  9. James J. Heckman & Carmen Pagés, 2004. "Introduction to "Law and Employment: Lessons from Latin American and the Caribbean"," NBER Chapters, in: Law and Employment: Lessons from Latin America and the Caribbean, pages 1-108 National Bureau of Economic Research, Inc.
  10. Friedrich Schneider & Dominik Enste, 2000. "Shadow Economies Around the World - Size, Causes, and Consequences," IMF Working Papers 00/26, International Monetary Fund.
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  13. Kanbur, Ravi, 2009. "Conceptualizing Informality: Regulation and Enforcement," Working Papers 48926, Cornell University, Department of Applied Economics and Management.
  14. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
  15. Olivier Charlot & Franck Malherbet & Cristina Terra, 2010. "Product Market Regulation, Firm Size, Unemployment and Informality in Developing Economies," Cahiers de recherche 1043, CIRPEE.
  16. Strobl, Eric & Walsh, Frank, 2003. "Minimum Wages and compliance : the case of Trinidad and Tobago," Open Access publications from University College Dublin urn:hdl:10197/184, University College Dublin.
  17. Gindling, T.H. & Terrell, Katherine, 2010. "Minimum Wages, Globalization, and Poverty in Honduras," World Development, Elsevier, vol. 38(6), pages 908-918, June.
  18. Pedro Portugal & Ana Rute Cardoso, 2002. "Disentangling the Minimum Wage Puzzle: An Analysis of Worker Accessions and Separations from Longitudinal Matched Employer-Employee Data Set," Working Papers w200208, Banco de Portugal, Economics and Research Department.
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Citations

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Cited by:
  1. Charlot, Olivier & Malherbet, Franck & Ulus, Mustafa, 2013. "Unemployment Compensation and the Allocation of Labor in Developing Countries," IZA Discussion Papers 7233, Institute for the Study of Labor (IZA).
  2. Hazans, Mihails, 2011. "Informal Workers across Europe: Evidence from 30 Countries," IZA Discussion Papers 5871, Institute for the Study of Labor (IZA).
  3. Basu, Arnab K. & Chau, Nancy & Siddique, Zahra, 2011. "Tax Evasion, Minimum Wage Non-Compliance and Informality," IZA Discussion Papers 6228, Institute for the Study of Labor (IZA).

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