IZA DP No. 4286: The Informal Sector Wage Gap: New Evidence Using Quantile Estimations on Panel Data
revised version published in: Economic Development and Cultural Change, 2015, 63 (1), 117-153
Most emerging economies are characterized by the presence of informal salary employment, often argued to be caused by stringent labor market regulation and to result in wage penalties compared to the formal sector. The actual picture is certainly more complex. In this paper, we use rich datasets for South Africa, Brazil and Mexico that allow us to define informality in a relatively comparable fashion across countries and to estimate precisely the (conditional) wage gap between informal and formal salary workers. We account for taxes paid in formal employment as well as for time-invariant unobserved heterogeneity, using large (unbalanced) panels and fixed effects quantile regression. Importantly, all three countries show a similar pattern once workers' heterogeneity is accounted for: informal sector wage penalties are significant in the lower part of the distribution but tend to disappear at the top. We provide an extensive robustness analysis and discuss the policy implications of these results.