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C H A P T ER 4
T H E L O NG S HA D O W O F I N F O R MA L I T Y
BOX 4.1 Informality and wage inequality
An extensive literature has documented the wage penalty for workers in the informal economy compared to their peers in the formal economy. Estimates of this penalty, however, vary substantially across countries. A comprehensive review of the relevant empirical studies suggests that the wage penalty largely reflects the characteristics of workers who self-select into informal activities. Worldwide, 2 billion people, or more than 60 percent of all workers aged 15 and over, have informal jobs (ILO 2018a). Informality is often associated with lower wages than the formal sector. If these lower wages reflect a wage penalty for informality that is independent of worker characteristics, policies that encourage the movement of workers to the formal sector might be a powerful remedy for income inequality and poverty. If, however, the wage differential largely reflects the characteristics of the workers employed in the informal sector, moving workers to the formal sector would be unlikely to achieve such gains. Persistent informality frequently overlaps with poverty because many working poor remain employed in the informal sector (ILO 2018b; box 4.3). Lower wages in the informal sector can result from different worker characteristics, possibly reflecting comparative advantage, or reflect nonwage benefits that might accrue to work in the informal sector (Heckman and Li 2003; Maloney 2004). Wage differences may also reflect subjective well-being or job satisfaction of workers in the formal and informal sectors, with informal jobs offering more flexibility and independence (see, for example, Blanchflower, Oswald, and Stutzer 2001; Falco et al. 2011; Sanfey and Teksoz 2007). Alternatively, wage differentials could stem from rigidities and other factors that create a wedge in wages between similar workers in informal and formal employment (Harris and Todaro 1970). This box sifts through a large body of empirical evidence on informal wage differentials to explore the following questions: •
What factors can create wage differentials between formal and informal sectors?
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How large is the wage gap between formal and informal jobs?
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What accounts for the wage gap between formal and informal jobs?
A comprehensive review of empirical models, identification strategies, estimation methods, and data sources delivers mixed results. Some studies detect a substantial formal wage premium over informal employment; other estimates, however, do not find a significant wage gap after controlling for individual and firm-specific characteristics. In light of these different findings, a meta-regression Note: This box was prepared by Sergiy Kasyanenko.
