Two-Tier Earnings Structures and labour Market Reform

Abstract

ABSTRACT Two-tier earnings structures have recently received renewed attention in the context of labour market reform, but relevant evidence for emerging economies is lacking. Relying on four waves of repeated cross-section individual-level micro data and Oaxaca-type earnings decompositions, this study investigates the interplay between the tightening of employment protection legislation in China through the introduction of the Labour Contract Law in 2008 and the earnings gap between covered and uncovered urban workers. It shows that in urban China average monthly earnings are significantly higher for workers with as compared to those without an employment contract and documents that labour market reform went hand in hand with a doubling in the log earnings gap. As there were no newly emerging differences in observable characteristics between the two groups of workers, this doubling was entirely due to reinforced impacts of differences in workers’ observable characteristics on earnings. Results are consistent with prominent theoretical models of a two-tier labour market, complement existing results for Europe and are robust to a wide range of alternative specifications, including those that addresses selection into labour force participation.