Labor Earnings Dynamics with a Large Informal Sector

We study labor earnings dynamics in a developing economy with a large informal sector. We use nationally representative Brazilian panel data that cover both formal and informal workers. We provide two main contributions. First, we document large disparities in earnings fluctuations faced across these segments of the labor market, as well as the high intensity of transitions between them. Informality is associated with more volatile earnings, while agents in the formal sector are subject to significant downside risk. Transitions across formal and informal employment bring large earnings shocks on average and have a frequency that depends on age and the initial earnings level. Second, we assess the consequences of these empirical disparities on decisions of consumption and savings. Our tool is a standard life cycle model with heterogeneous agents where the earnings processes are estimated to reflect the aforementioned empirical findings. The simulations reveal sizable impacts.