What drives the spatial wage premium in formal and informal labor markets? The case of Ecuador

Abstract

AbstractThis article investigates the incidence of agglomeration externalities in Ecuador, a small‐sized, middle‐income developing country. In particular, we analyze the role of the informal sector within these relations, since informal employment accounts for a significant part of total employment in the developing countries. Using individual level data and instrumental variable techniques, we investigate the impact of spatial externalities, in terms of population density, local specialization and urban size, on the wages of workers in Ecuadorian cities. The results show that spatial externalities matter also for a small developing country. Moreover, analysis of the interaction between spatial externalities and informality shows that, on average, workers employed in the informal sector do not enjoy significant benefits from agglomeration externalities. Finally, by investigating the possible channels behind spatial agglomeration gains we show that the advantages from agglomeration for formal sector workers may well be accounted for by better job‐quality matches and, to a lesser extent, by learning externalities. For informal sector workers, our findings also suggest possible gains from job changes, which offset a penalty for remaining employed in the same occupation.