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Contractual Dualism, Market Power and Informality

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Author Info

  • Basu, Arnab K.

    ()
    (Cornell University)

  • Chau, Nancy

    ()
    (Cornell University)

  • Kanbur, Ravi

    ()
    (Cornell University)

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 Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 5845.

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Length: 47 pages
Date of creation: Jul 2011
Date of revision:
Handle: RePEc:iza:izadps:dp5845

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Keywords: contractual dualism; wage dualism; employer market power; informality;

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  1. Pedro Portugal & Ana Rute Cardoso, 2006. "Disentangling the Minimum Wage Puzzle: An Analysis of Worker Accessions and Separations," Journal of the European Economic Association, MIT Press, MIT Press, vol. 4(5), pages 988-1013, 09.
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  6. Ravi Kanbur, 2009. "Conceptualising Informality: Regulation and Enforcement," Working Papers id:2005, eSocialSciences.
  7. Gong, Xiaodong & Van Soest, Arthur & Villagomez, Elizabeth, 2004. "Mobility in the Urban Labor Market: A Panel Data Analysis for Mexico," Economic Development and Cultural Change, University of Chicago Press, University of Chicago Press, vol. 53(1), pages 1-36, October.
  8. Charlot Olivier & Malherbet Franck & Terra Cristina, 2011. "Product market regulation, firm size, unemployment and informality in developing economies," THEMA Working Papers 2011-03, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
  9. Gong, Xiaodong & van Soest, Arthur, 2002. "Wage differentials and mobility in the urban labour market: a panel data analysis for Mexico," Labour Economics, Elsevier, Elsevier, vol. 9(4), pages 513-529, September.
  10. Lemos, Sara, 2004. "The Effects of the Minimum Wage in the Formal and Informal Sectors in Brazil," IZA Discussion Papers 1089, Institute for the Study of Labor (IZA).
  11. Gindling, T.H. & Terrell, Katherine, 2010. "Minimum Wages, Globalization, and Poverty in Honduras," World Development, Elsevier, Elsevier, vol. 38(6), pages 908-918, June.
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  13. Friedrich Schneider & Dominik Enste, 2000. "Shadow Economies Around the World," IMF Working Papers 00/26, International Monetary Fund.
  14. 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, Banco de Portugal, Economics and Research Department w200208, Banco de Portugal, Economics and Research Department.
  15. James Heckman & Carmen Pages, 2003. "Law and Employment: Lessons from Latin America and the Caribbean," NBER Working Papers 10129, National Bureau of Economic Research, Inc.
  16. Strobl, Eric & Walsh, Frank, 2003. "Minimum Wages and Compliance: The Case of Trinidad and Tobago," Economic Development and Cultural Change, University of Chicago Press, University of Chicago Press, vol. 51(2), pages 427-50, January.
  17. Gindling, T.H. & Terrell, Katherine, 2007. "The effects of multiple minimum wages throughout the labor market: The case of Costa Rica," Labour Economics, Elsevier, Elsevier, vol. 14(3), pages 485-511, June.
  18. James J. Heckman & Carmen Pagés, 2004. "Introduction to "Law and Employment: Lessons from Latin American and the Caribbean"," NBER Chapters, National Bureau of Economic Research, Inc, in: Law and Employment: Lessons from Latin America and the Caribbean, pages 1-108 National Bureau of Economic Research, Inc.
  19. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, Elsevier, vol. 35(1), pages 33-47, January.
  20. Ramey, Garey & Watson, Joel, 1997. "Contractual Fragility, Job Destruction, and Business Cycles," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 112(3), pages 873-911, August.
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Cited by:
  1. 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).
  2. Hazans, Mihails, 2011. "Informal Workers across Europe: Evidence from 30 Countries," IZA Discussion Papers 5871, Institute for the Study of Labor (IZA).
  3. 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).

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