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Informal Labor Markets and Macroeconomic Fluctuations

This paper examines the adjustment of developing country labor markets to macroeconomic shocks. It models a two sector labor market: a formal salaried (tradable) sector that may or may not be affected by union or legislation induced wage rigidities, and an unregulated (nontradable) self-employment sector facing liquidity constraints to entry. This is embedded in a standard small economy macro model that permits the derivation of patterns of comovement among relative salaried/self-employed incomes, salaried/self-employed sector sizes and the real exchange rate with respect to different types of shocks in contexts with and without wage rigidities. The paper then explores time series data from Argentina, Brazil, Colombia and Mexico to test for cointegrating relationships corresponding to the patterns predicted by theory. We identify two types of regime. The first corresponds to periods where demand shocks to the nontradable sector offer new opportunities to (informal) entrepreneurs, the informal sector expands “procyclically,” and the exchange rate overshoots toward appreciation in the short run, or remains at its productivity determined levels. The second corresponds to periods of negative shocks to the formal salaried sector in the presence of wage rigidities where the sector plays a more traditional “buffer” role during downturns.

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Paper provided by Business School - Economics, University of Glasgow in its series Working Papers with number 2006_17.

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Date of creation: Nov 2006
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Handle: RePEc:gla:glaewp:2006_17
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Web page: http://www.gla.ac.uk/schools/business/research/

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  1. Craig S. Hakkio & Mark Rush, 1990. "Cointegration: how short is the long run?," Research Working Paper 90-08, Federal Reserve Bank of Kansas City.
  2. Evans, David S & Leighton, Linda S, 1989. "Some Empirical Aspects of Entrepreneurship," American Economic Review, American Economic Association, vol. 79(3), pages 519-35, June.
  3. 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.
  4. James J. Heckman & Carmen Pagés, 2004. "Law and Employment: Lessons from Latin America and the Caribbean," NBER Books, National Bureau of Economic Research, Inc, number heck04-1.
  5. Henrik Hansen & Søren Johansen, 1999. "Some tests for parameter constancy in cointegrated VAR-models," Econometrics Journal, Royal Economic Society, vol. 2(2), pages 306-333.
  6. Søren Johansen & Katarina Juselius, 1992. "Identification of the Long-Run and the Short-Run Structure: An Application to the ISLM Model," Discussion Papers 92-04, University of Copenhagen. Department of Economics.
  7. Pratap, Sangeeta & Quintin, Erwan, 2006. "Are labor markets segmented in developing countries? A semiparametric approach," European Economic Review, Elsevier, vol. 50(7), pages 1817-1841, October.
  8. Hamilton, Jonathan & Thisse, Jacques-Francois & Zenou, Yves, 2000. "Wage Competition with Heterogeneous Workers and Firms," Journal of Labor Economics, University of Chicago Press, vol. 18(3), pages 453-72, July.
  9. Fugazza, Marco & Fiess, Norbert M. & Maloney, William, 2002. "Exchange rate appreciations, labor market rigidities, and informality," Policy Research Working Paper Series 2771, The World Bank.
  10. Loayza, Norman V. & Rigolini, Jamele, 2006. "Informality trends and cycles," Policy Research Working Paper Series 4078, The World Bank.
  11. William Maloney & Jairo Mendez, 2004. "Measuring the Impact of Minimum Wages. Evidence from Latin America," NBER Chapters, in: Law and Employment: Lessons from Latin America and the Caribbean, pages 109-130 National Bureau of Economic Research, Inc.
  12. Maloney, William, 2003. "Informality revisited," Policy Research Working Paper Series 2965, The World Bank.
  13. Blanchard, Olivier Jean & Kiyotaki, Nobuhiro, 1987. "Monopolistic Competition and the Effects of Aggregate Demand," American Economic Review, American Economic Association, vol. 77(4), pages 647-66, September.
  14. Andalón, Mabel & Pagés, Carmen, 2008. "Minimum Wages in Kenya," IZA Discussion Papers 3390, Institute for the Study of Labor (IZA).
  15. Maloney, William F., 1998. "The structure of labor markets in developing countries : time series evidence on competing views," Policy Research Working Paper Series 1940, The World Bank.
  16. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
  17. Evans, David S & Jovanovic, Boyan, 1989. "An Estimated Model of Entrepreneurial Choice under Liquidity Constraints," Journal of Political Economy, University of Chicago Press, vol. 97(4), pages 808-27, August.
  18. Cheung, Yin-Wong & Lai, Kon S, 1993. "Finite-Sample Sizes of Johansen's Likelihood Ration Tests for Conintegration," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 55(3), pages 313-28, August.
  19. Mazumdar, Dipak, 1976. "The urban informal sector," World Development, Elsevier, vol. 4(8), pages 655-679, August.
  20. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
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