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Is the Formal Sector too Large or too Small? A Reexamination of Minimum Wages in Developing Countries

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  • Frédéric Gavrel

    (University of Caen Basse-Normandie, France - CREM-CNRS)

Abstract

This paper reexamines the issue of the division of the labor force between the two sub-markets (formal and informal) of a developing economy. The formal sector is represented by a matching model with vertically differentiated workers. Assuming that firms hire their best applicants, we state that the formal sector is too small in terms of its labor force but too large in terms of job creation. Next we show that introducing a minimum wage increases the size of the formal sector with respect both to its labor force and to job creation. In accordance with the well-known paradox of Harris and Todaro, the enlargement of the formal market is accompanied by a rise in unemployment. However, when associated with a tax on job creation, the introduction of a minimum wage in the formal sector improves the efficiency of the labor market by making the formal sector more attractive to workers.

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Paper provided by Center for Research in Economics and Management (CREM), University of Rennes 1, University of Caen and CNRS in its series Economics Working Paper Archive (University of Rennes 1 & University of Caen) with number 201108.

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Date of creation: Jul 2011
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Handle: RePEc:tut:cremwp:201108

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Keywords: Formal and informal labor markets; applicant ranking; efficiency; minimum wage;

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References

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  1. Gavrel, Frédéric, 2011. "On the efficiency of participation with vertically differentiated workers," Economics Letters, Elsevier, vol. 112(1), pages 100-102, July.
  2. James Albrecht & Lucas Navarro & Susan Vroman, 2008. "The Effects of Labour Market Policies in an Economy with an Informal Sector," ILADES-Georgetown University Working Papers, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines inv208, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
  3. Gavrel, Frédéric, 2009. "Technical skill bias as a response of firms to unemployment: A matching model with applicant ranking and endogenous skill requirements," Labour Economics, Elsevier, vol. 16(3), pages 304-310, June.
  4. Harris, John R & Todaro, Michael P, 1970. "Migration, Unemployment & Development: A Two-Sector Analysis," American Economic Review, American Economic Association, vol. 60(1), pages 126-42, March.
  5. Margaret Stevens, 2007. "New Microfoundations For The Aggregate Matching Function," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 48(3), pages 847-868, 08.
  6. Holmlund, B., 1997. "Unemployment Insurance in Theory and Practice," Papers, Uppsala - Working Paper Series 1997-25, Uppsala - Working Paper Series.
  7. Albrecht, James W. & Gautier, Pieter A. & Vroman, Susan B., 2003. "Matching with multiple applications," Economics Letters, Elsevier, vol. 78(1), pages 67-70, January.
  8. Gavrel, Frédéric, 2012. "On the inefficiency of matching models of unemployment with heterogeneous workers and jobs when firms rank their applicants," European Economic Review, Elsevier, vol. 56(8), pages 1746-1758.
  9. Zenou, Yves, 2008. "Job search and mobility in developing countries. Theory and policy implications," Journal of Development Economics, Elsevier, vol. 86(2), pages 336-355, June.
  10. James Albrecht, Pieter Gautier, & Susan Vroman, 2003. "Matching with Multiple Applications: The Limiting Case," Working Papers gueconwpa~03-03-25, Georgetown University, Department of Economics.
  11. Albrecht, James & Navarro, Lucas & Vroman, Susan, 2009. "Efficiency in a Search and Matching Model with Endogenous Participation," IZA Discussion Papers 4097, Institute for the Study of Labor (IZA).
  12. Moen, Espen R, 1999. "Education, Ranking, and Competition for Jobs," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 17(4), pages 694-723, October.
  13. Barbara Petrongolo & Christopher A. Pissarides, 2000. "Looking Into the Black Box: A Survey of the Matching Function," CEP Discussion Papers dp0470, Centre for Economic Performance, LSE.
  14. Gary Fields & Ravi Kanbur, 2007. "Minimum wages and poverty with income-sharing," Journal of Economic Inequality, Springer, vol. 5(2), pages 135-147, August.
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