Trade Liberalization and Informal Labor Markets

Abstract

In recent decades, economic reforms and technological advances have profoundly altered the way employers do business—for instance, the nature of employment relationships, the skills firms demand, and the goods and services they produce and export. In many developing economies, these changes took place concurrently with a substantive rise in work outside of the formal economy. According to International Labour Organization estimates, informal employment can be as high as 88% of total employment in India, almost 50% in Brazil, and around 35% of employment in South Africa. Such informal employment is typically associated with lower wages, lower productivity, poorer working conditions, weaker employment protections, and fewer job benefits and amenities, and these informal workers are often poorer and more vulnerable than their counterparts in the formalized economy. Informal jobs are a consequence of labor market policies—like severance payments or social security contributions—that make the noncompliant informal job cheaper for the employer than a compliant formal job. Each model has a different benefit (or lack of punishment) for employing formal workers, and a distinct mechanism through which international trade shocks alter the benefit-cost of these types of jobs, which in turn results in a change in the informality share. The empirical literature concerning international trade and formality largely points to an unambiguous increase in informal employment in the aftermath of increased import competition. Interestingly, increased access to foreign markets, via liberalization of major trading partners, offers strongly positive implications for formal employment opportunities, decreasing informality. Such effects are moderated by the de facto enforcement of labor regulations. Expansions toward the formal economy and away from informal wage employment in the aftermath of increased access to foreign markets are smaller in strictly enforced areas of the country.