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


  • Benjamin Aleman-Castilla


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.

Suggested Citation

  • Benjamin Aleman-Castilla, 2006. "The Effect of Trade Liberalization on Informality and Wages: Evidence from Mexico," CEP Discussion Papers dp0763, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp0763

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    References listed on IDEAS

    1. Fernandes, Ana M., 2007. "Trade policy, trade volumes and plant-level productivity in Colombian manufacturing industries," Journal of International Economics, Elsevier, vol. 71(1), pages 52-71, March.
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    5. Revenga, Ana, 1995. "Employment and wage effects of trade liberalization : the case of Mexican manufacturing," Policy Research Working Paper Series 1524, The World Bank.
    6. Kate, Adriaan Ten & Macario, Carla & Niels, Gunnar, 2000. "Mexico: export promotion policies on the cutting edge," Copublicaciones, Naciones Unidas Comisión Económica para América Latina y el Caribe (CEPAL), number 1643, September.
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    10. repec:rus:hseeco:122439 is not listed on IDEAS
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    14. 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.
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    Cited by:

    1. Bosch, Mariano & Manacorda, Marco, 2008. "Minimum wages and earnings inequality in urban Mexico. Revisiting the evidence," LSE Research Online Documents on Economics 19561, London School of Economics and Political Science, LSE Library.
    2. Nihar Shembavnekar, 2015. "Tariff Liberalisation, Labour Market Flexibility and Employment: Evidence from India," Working Paper Series 8115, Department of Economics, University of Sussex.
    3. Matthew Embrey & Guillaume R. Frechette & Sevgi Yuksel, 2016. "Cooperation in the Finitely Repeated Prisoner's Dilemma," Working Paper Series 8616, Department of Economics, University of Sussex.
    4. L. Alan Winters & Antonio Martuscelli, 2014. "Trade Liberalization and Poverty: What Have We Learned in a Decade?," Annual Review of Resource Economics, Annual Reviews, vol. 6(1), pages 493-512, October.
    5. Maiti, Dibyendu & Mukherjee, Arijit, 2013. "Trade cost reduction, subcontracting and unionised wage," Labour Economics, Elsevier, vol. 21(C), pages 103-110.
    6. Mathan Satchi & Jonathan Temple, 2009. "Labor Markets and Productivity in Developing Countries," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 12(1), pages 183-204, January.
    7. Benjamin Aleman-Castilla, 2007. "The Returns to Temporary Migration to the United States: Evidence from the Mexican Urban Employment Survey," CEP Discussion Papers dp0804, Centre for Economic Performance, LSE.
    8. Aleman-Castilla, Benjamin, 2007. "The returns to temporary migration to the United States: evidence from the Mexican urban employment survey," LSE Research Online Documents on Economics 19706, London School of Economics and Political Science, LSE Library.
    9. Dibyendu Maiti & Arijit Mukherjee, "undated". "Trade Liberalisation, Subcontracting and Unionised Wage," Discussion Papers 10/07, University of Nottingham, GEP.

    More about this item


    trade liberalization; informality; wage differentials;

    JEL classification:

    • F00 - International Economics - - General - - - General
    • F02 - International Economics - - General - - - International Economic Order and Integration
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F15 - International Economics - - Trade - - - Economic Integration
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • J00 - Labor and Demographic Economics - - General - - - General
    • J21 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Force and Employment, Size, and Structure
    • J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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