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The Formal Sector Wage Premium and Firm Size for Self-employed Workers

  • Bargain, Olivier

    ()

    (University of Aix-Marseille II)

  • El Badaoui, Eliane

    ()

    (University Paris Ouest-Nanterre)

  • Kwenda, Prudence

    ()

    (University College Dublin)

  • Strobl, Eric

    ()

    (Ecole Polytechnique, Paris)

  • Walsh, Frank

    ()

    (University College Dublin)

We develop a model where formal sector firms pay tax and informal ones do not, but informal firms risk incurring the penalty associated with non-compliance. Workers may enter self-employment or search for jobs as employees. Workers with higher managerial skills will run larger firms while workers with lower will manage smaller firms and will be in self-employment only when they cannot find a salary job. For these workers self-employment is a secondary/informal form of employment. The Burdett and Mortensen (1998) equilibrium search model turns out to be a special case that we amend by incorporating taxes and a penalty for non-payment of taxes. Our model is also consistent with some of the empirical literature in that the informal wage penalty does appear to be limited to low wage/skill workers while firm size is an important determinant of the employee formal sector premium. We test theoretical predictions using empirical evidence from Mexico and find that firm size wage effects for employees and self-employed workers are broadly consistent with the model.

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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 6604.

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Length: 41 pages
Date of creation: May 2012
Date of revision:
Handle: RePEc:iza:izadps:dp6604
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  1. Amaral, Pedro S. & Quintin, Erwan, 2006. "A competitive model of the informal sector," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1541-1553, October.
  2. 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.
  3. Gabriela Inchauste & Mark Gradstein & Era Dabla-Norris, 2005. "What Causes Firms to Hide Output? the Determinants of Informality," IMF Working Papers 05/160, International Monetary Fund.
  4. Pradhan, Menno & van Soest, Arthur, 1995. "Formal and informal sector employment in urban areas of Bolivia," Labour Economics, Elsevier, vol. 2(3), pages 275-297, September.
  5. McKenzie, David & Seynabou Sakho, Yaye, 2010. "Does it pay firms to register for taxes? The impact of formality on firm profitability," Journal of Development Economics, Elsevier, vol. 91(1), pages 15-24, January.
  6. El Badaoui, Eliane & Strobl, Eric & Walsh, Frank, 2010. "The formal sector wage premium and firm size," Journal of Development Economics, Elsevier, vol. 91(1), pages 37-47, January.
  7. Robert E. Lucas Jr., 1978. "On the Size Distribution of Business Firms," Bell Journal of Economics, The RAND Corporation, vol. 9(2), pages 508-523, Autumn.
  8. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
  9. Fugazza, Marco & Jacques, Jean-Francois, 2004. "Labor market institutions, taxation and the underground economy," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 395-418, January.
  10. James Albrecht & Lucas Navarro & Susan Vroman, 2006. "The Effects of Labor Market Policies in an Economy with an Informal Sector," Working Papers gueconwpa~06-06-06, Georgetown University, Department of Economics.
  11. Cunningham, Wendy V & Maloney, William F, 2001. "Heterogeneity among Mexico's Microenterprises: An Application of Factor and Cluster Analysis," Economic Development and Cultural Change, University of Chicago Press, vol. 50(1), pages 131-56, October.
  12. Fiess, Norbert M. & Fugazza, Marco & Maloney, William F., 2010. "Informal self-employment and macroeconomic fluctuations," Journal of Development Economics, Elsevier, vol. 91(2), pages 211-226, March.
  13. Teal, Francis, 2011. "The price of labour and understanding the causes of poverty," Labour Economics, Elsevier, vol. 18(S1), pages S7-S15.
  14. Aysit Tansel, 1999. "Formal Versus Informal Sector Choice of Wage Earners and their Wages in Turkey," Working Papers 9927, Economic Research Forum, revised Sep 1999.
  15. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  16. Mazumdar, Dipak, 1975. "The Theory of Share-Cropping with Labour Market Dualism," Economica, London School of Economics and Political Science, vol. 42(167), pages 261-71, August.
  17. repec:dgr:kubcen:200046 is not listed on IDEAS
  18. Ulyssea, Gabriel, 2010. "Regulation of entry, labor market institutions and the informal sector," Journal of Development Economics, Elsevier, vol. 91(1), pages 87-99, January.
  19. repec:ner:tilbur:urn:nbn:nl:ui:12-80489 is not listed on IDEAS
  20. Günther, Isabel & Launov, Andrey, 2012. "Informal employment in developing countries," Journal of Development Economics, Elsevier, vol. 97(1), pages 88-98.
  21. Olivier Bargain & Prudence Kwenda, 2011. "Earnings Structures, Informal Employment, And Self‐Employment: New Evidence From Brazil, Mexico, And South Africa," Review of Income and Wealth, International Association for Research in Income and Wealth, vol. 57, pages S100-S122, 05.
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