The Effect of Expected Wage Differentials on the Informal Sector Open Access

Abstract

 

Following informal sector literature’s infatuation with urbanization, this paper seeks to push authors to look under the hood of the urbanization phenomenon to explore the underlying engine as a means of understanding how to make better policy recommendations that allow governments to take the wheel with their informal sectors. Motivated by the Harris-Todaro Model for migration, I principally investigate the explanatory power urban-rural expected wage differentials have on the size of the informal sectors. As a result, I specify a Pooled OLS model including year dummies, and find a significant, positive effect suggesting governments can target reducing the urban-rural wage differential in order to limit and reduce the size of the informal sector. Second, I examine how government budget allocations on public healthcare and education affect the size of the informal sector, where I find slight evidence for increases in spending being associated with increases in the informal sector size. To this effect, the welfare spending result produces more questions than it does answers; there will need to be further research with attention to the urban-rural split of expenditure to make any concrete claims or recommendations. Concluding the study, I recommend governments subsidize the rural, agricultural sector with the help of urban, industrial tax revenues to subdue and shrink the informal sector. Additionally, governments should both evaluate current and future economic policy with the question of how a decision might affect the urban-rural expected wage differential to ensure it is not so urban-centric as to cause a burgeoning informal sector.

 

Table of Contents

 

Introduction......................................................................................................................... 1

Theoretical Framing............................................................................................................ 3

Data and Empirical Strategy............................................................................................... 8

Results............................................................................................................................... 17

Discussion......................................................................................................................... 24

Appendix........................................................................................................................... 29

References......................................................................................................................... 30

Tables.................................................................................................................................

Figure 1: Income Inequality and Size of the Informal Sector by Urban Share of Population............................................................................................................. 7

Table 1: Summary Statistics of MIMIC Sample................................................. 14

Table 2: Summary Statistics of DSGE Sample................................................... 15

Table 3: Sample Makeup Analysis...................................................................... 15

Table 4: Correlation Matrix of MIMIC Sample.................................................. 16

Table 5: Correlation Matrix of DSGE Sample.................................................... 16

Table 6: Pooled OLS and 2SLS IV Coefficient Estimates.................................. 17

Table 7: Endogeneity Test Results....................................................................... 21

Table 8: Fixed Effects Coefficient Estimates....................................................... 21

Table 9: Pooled OLS and Pooled 2SLS IV with Year Dummies Coefficient Estimates.............................................................................................................. 23  

Table 10: First Stage Summary Statistics............................................................ 28

Table 11: 2SLS Wald Test for IV Strength.......................................................... 28

About this Honors Thesis

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School	Emory College
Department	Economics
Degree	B.A.
Submission	Honors Thesis
Language	English
Research Field	Economics, General Economics, Labor
Keyword	Urbanization Urban Wages Rural
Committee Chair / Thesis Advisor	Streeb, Gordon, Emory University Mialon, Sue, Emory University
Committee Members	Doner, Richard , Emory University

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