Workforce Composition, Productivity, and Labor Regulations in a Compensating Differentials Theory of Informality

93 Pages Posted: 21 Apr 2020

See all articles by Daniel Haanwinckel

Daniel Haanwinckel

University of California, Berkeley

Rodrigo R. Soares

Columbia University - School of International & Public Affairs (SIPA); Getulio Vargas Foundation (FGV) - Sao Paulo School of Economics; IZA Institute of Labor Economics

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Date Written: April 17, 2020

Abstract

We develop a search model of informal labor markets with worker and firm heterogeneity, intra-firm bargaining with imperfect substitutability across types of workers, and a comprehensive set of labor regulations, including minimum wage. Stylized facts associated with the informal sector, such as smaller firms and lower wages, emerge endogenously as firms and workers decide whether to comply with regulations. Imperfect substitutability across types of workers, decreasing returns to scale, and convex vacancy-posting costs enable the model to reproduce empirical patterns incompatible with existing frameworks in the literature: the presence of skilled and unskilled workers in the formal and informal sectors, the rising share of skilled workers by firm size, the declining formal wage premium by skill, and the rising firm-size wage premium by skill. These features also allow us to analyze the equilibrium responses to changes in the demand and supply of different types of labor. We estimate the model using Brazilian data and show that it reproduces various margins of labor market changes observed between 2003 and 2012. The change in the composition of the labor force appears as the main driving force behind the reduction in informality. We illustrate the use of the model for policy analysis by assessing the effectiveness of a progressive payroll tax in reducing informality.

Keywords: informality, labor market, search, minimum wage, compensating differentials, Brazil

JEL Classification: J24, J31, J46, J64, O17

Suggested Citation

Haanwinckel, Daniel and Soares, Rodrigo R., Workforce Composition, Productivity, and Labor Regulations in a Compensating Differentials Theory of Informality (April 17, 2020). University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020-45, Available at SSRN: https://ssrn.com/abstract=3579086 or http://dx.doi.org/10.2139/ssrn.3579086

Daniel Haanwinckel (Contact Author)

University of California, Berkeley

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Rodrigo R. Soares

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Getulio Vargas Foundation (FGV) - Sao Paulo School of Economics ( email )

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IZA Institute of Labor Economics

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