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The Effect of Trade Liberalization on Informality and Wages: Evidence from Mexico

  • Benjamin Aleman-Castilla
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    This paper studies the impact of NAFTA on informality and real wages in Mexico. Using a dynamic industry model with firm heterogeneity, it is predicted that import tariff elimination could reduce the incidence of informality by making more profitable to some firms to enter the formal sector, forcing the less productive informal firms to exit the industry, and inducing the most productive formal firms to engage in trade. The model also predicts market share reallocations towards the most productive firms, and an increase in real wages due to the increased labour demand by these firms. Using data on Mexican and U.S. import tariffs together with the Mexican National Survey of Urban Labour (ENEU), I find that reductions in the Mexican import tariffs are significantly related to reductions in the likelihood of informality in the tradable industries. I also find that informality decreases less in industries with higher levels of import penetration, while it decreases more in industries that are relatively more export oriented. Finally, I confirm that the elimination of the Mexican import tariffs is related to an increase in real wages, and that the elimination of the U.S. import tariff has contributed to the expansion of the formal-informal wage differentials.

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    File URL: http://cep.lse.ac.uk/pubs/download/dp0763.pdf
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    Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0763.

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    Date of creation: Dec 2006
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    Handle: RePEc:cep:cepdps:dp0763
    Contact details of provider: Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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    1. Marc J. Melitz, 2003. "The Impact of Trade on Intra-Industry Reallocations and Aggregate Industry Productivity," Econometrica, Econometric Society, vol. 71(6), pages 1695-1725, November.
    2. Ana Fernandes, 2002. "Trade Policy, Trade Volumes and Plant-Level Productivity in Colombian Manufacturing Industries," Working Papers 847, Economic Growth Center, Yale University.
    3. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
    4. Pavcnik, Nina, 2002. "Trade Liberalization, Exit, and Productivity Improvement: Evidence from Chilean Plants," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 245-76, January.
    5. Nicita, Alessandro, 2004. "Who benefited from trade liberalization in Mexico? Measuring the effects on household welfare," Policy Research Working Paper Series 3265, The World Bank.
    6. John Baldwin & Wulong Gu, 2009. "The Impact of Trade on Plant Scale, Production-Run Length and Diversification," NBER Chapters, in: Producer Dynamics: New Evidence from Micro Data, pages 557-592 National Bureau of Economic Research, Inc.
    7. Gordon H. Hanson, 1994. "Regional Adjustment to Trade Liberalization," NBER Working Papers 4713, National Bureau of Economic Research, Inc.
    8. Pedro Cavalcanti Ferreira & JosÈ Luiz Rossi, 2003. "New Evidence from Brazil on Trade Liberalization and Productivity Growth," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1383-1405, November.
    9. Currie, Janet & Harrison, Ann E, 1997. "Sharing the Costs: The Impact of Trade Reform on Capital and Labor in Morocco," Journal of Labor Economics, University of Chicago Press, vol. 15(3), pages S44-71, July.
    10. repec:rus:hseeco:122439 is not listed on IDEAS
    11. Koujianou Goldberg, Pinelopi & Pavcnik, Nina, 2003. "The response of the informal sector to trade liberalization," Journal of Development Economics, Elsevier, vol. 72(2), pages 463-496, December.
    12. Maloney, William F, 1999. "Does Informality Imply Segmentation in Urban Labor Markets? Evidence from Sectoral Transitions in Mexico," World Bank Economic Review, World Bank Group, vol. 13(2), pages 275-302, May.
    13. Revenga, Ana, 1995. "Employment and wage effects of trade liberalization : the case of Mexican manufacturing," Policy Research Working Paper Series 1524, The World Bank.
    14. Donald R. Davis, 1996. "Trade Liberalization and Income Distribution," Harvard Institute of Economic Research Working Papers 1769, Harvard - Institute of Economic Research.
    15. Orazio Attanasio & Pinelopi Goldberg & Nina Pavcnik, 2003. "Trade Reforms and Wage Inequiality in Colombia," NBER Working Papers 9830, National Bureau of Economic Research, Inc.
    16. Harrison, Ann E., 1994. "Productivity, imperfect competition and trade reform : Theory and evidence," Journal of International Economics, Elsevier, vol. 36(1-2), pages 53-73, February.
    17. Gordon H. Hanson & Ann Harrison, 1999. "Trade liberalization and wage inequality in Mexico," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 52(2), pages 271-288, January.
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