Abstract
While several studies have documented the expansion of the informal sector and its detrimental impact on development, few have noted that informality and wage inequality tend to move together. Using Mexico as a case study, I show that between 1987 and 2002 wage inequality within informal workers accounted for over 60 % of total wage inequality and that the Mexican financial crisis of the mid-1990s increased the share of informal workers and, via this, wage inequality. The results provide supportive evidence that in Mexico higher wage dispersion is one of the channels through which informality negatively affects development.
Highlights
Informal labour markets are widespread, in low- and middle-income countries
An interesting case study is provided by Mexico, where in the 1990s the co-movement between informality and wage inequality was strong
Using Mexican data from 1987–2002, I first show that in each year of the sample wage inequality within informal workers accounted for over 60 % of total wage inequality, and I use an instrumental variable strategy to show that the peso crisis of the mid-1990s was one of the channels through which informality affected wage inequality
Summary
Informal labour markets are widespread, in low- and middle-income countries. In their survey of the literature, Schneider and Enste (2000) find that at the beginning of the 1990s in most countries in Africa, Asia and Central and South America the informal sector accounted for over half of aggregate GDP. A growing literature has shown that countries with poorly functioning institutions, labour rigidities, a heavy tax burden and high levels of corruption tend to have large informal sectors (Loayza 1996; Johnson et al 1998; Botero et al 2004; Vuletin 2009) and lower aggregate welfare (Meghir et al 2015). Pratap and Quintin (2006) find that informal output represents 10–15 % of GDP in most high-income countries, compared to 25–80 % in most low- and middle-income countries
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