The Structure of Labor Markets in Developing Countries: Time Series Evidence on Competing Views

Abstract

The informal sector behaves as an unregulated entrepreneurial sector rather than the disadvantaged segment of a dual labor market. Overall, it expands in upturns and contracts in downturns, though there is some evidence of queuing to enter the formal sector. Competing conceptions of the large, unprotected, informal workforce in developing countries differ greatly in their implications for the labor reform considered to be essential complements to trade liberalization and fair competition in international trade. Traditionally, the informal sector is viewed as the disadvantaged segment of a dual labor market segmented by legislated or union-induced rigidities and high labor costs in the protected (or formal) sector. In this view, the size of the informal sector is a testament to the inefficiencies in labor allocation and the magnitude of required reform. In cyclical downturns, the informal sector is thought to absorb displaced workers from the formal sector (with informal earnings falling relative to those in the formal sector) and then to contract again during recovery as the queue for good jobs shortens again. A recent, related view postulates a long-term trend in which large enterprises, confronted by heightened global competition, increasingly subcontracts to unprotected workers as a way to reduce costs and gain flexibility. This is particularly relevant in the debate about establishing common labor standards in regional trade agreements. Maloney reexamines the traditional view of the dual labor market by studying the dynamics between the formal and informal sectors across a business cycle and a period of trade liberalization in Mexico (1987-93). He shows conventional comparisons of earnings, even across time, to be unreliable tests for segmentation. As an alternative, he shows that transitions on informal employment, the size of the informal sector, and levels of mobility to be procyclical, increasing with upturns, and decreasing with recessions. He tests for, and finds, however, some evidence of queuing to enter formal employment. Overall, he contends, the informal sector behaves as an unregulated entrepreneurial sector rather than the disadvantaged wing of a dual labor market. There is evidence of increased subcontracting over time, with trade liberalization, but it is not clear that workers are worse off as a result. This paper - a product of the Poverty and Economic Management Unit, Latin America and the Caribbean Region - is part of a larger effort in the region to reexamine the role of the informal sector. The study was funded by the Bank`s Research Support Budget under the research project The Informal Sector in Mexico (RPO 680-59). The author may be contacted at wmaloney@worldbank.org.