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http://ssrn.com/abstract=1893925
 
 

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Contractual Dualism, Market Power and Informality


Arnab K. Basu


College of William and Mary - Department of Economics

Nancy H. Chau


Cornell University - School of Applied Economics and Management; Institute for the Study of Labor (IZA)

Ravi Kanbur


Cornell University - School of Applied Economics and Management; Centre for Economic Policy Research (CEPR); Institute for the Study of Labor (IZA)


IZA Discussion Paper No. 5845

Abstract:     
Two stylized representations are often found in the academic and policy literature on informality and formality in developing countries. The first is that the informal (or unregulated) sector is more competitive than the formal (or regulated) sector. The second is that contract enforcement is easier in the formal sector than in the informal sector, precisely because the formal sector comes under the purview of state regulation. The basic contention of this paper is that these two representations are not compatible with each other. We develop a search-theoretic model of contractual dualism in the labor market where the inability to commit to contracts in the informal sector leads to employer market power in equilibrium, while an enforced minimum wage in the formal sector provides employers with a commitment technology but which reduces their market power in equilibrium. The contributions of this paper are three-fold. It (i) provides the micro-underpinnings for endogenous determination of employer market power in the formal and informal sectors due to contractual dualism in the two sectors, (ii) offers a unified and coherent setup whereby a host of salient features of developing country labor markets can be explained together, and (iii) places the original Stiglerian prescription of the optimal (unemployment minimizing) minimum wage in the broader context of labor markets where formal job creation is costly, and where formal employment, informal employment, and unemployment co-exist.

Number of Pages in PDF File: 47

Keywords: contractual dualism, wage dualism, employer market power, informality

JEL Classification: J3, J6, O17

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Date posted: July 24, 2011  

Suggested Citation

Basu, Arnab K. and Chau, Nancy H. and Kanbur, Ravi, Contractual Dualism, Market Power and Informality. IZA Discussion Paper No. 5845. Available at SSRN: http://ssrn.com/abstract=1893925

Contact Information

Arnab K. Basu (Contact Author)
College of William and Mary - Department of Economics ( email )
Williamsburg, VA 23187-8795
United States
757-221-1318 (Phone)
757-221-1175 (Fax)
HOME PAGE: http://faculty.wm.edu/akbasu/
Nancy H. Chau
Cornell University - School of Applied Economics and Management ( email )
Ithaca, NY 14853
United States
607-255-4463 (Phone)
607-255-9984 (Fax)
Institute for the Study of Labor (IZA)
P.O. Box 7240
Bonn, D-53072
Germany
Ravi Kanbur
Cornell University - School of Applied Economics and Management ( email )
248 Warren Hall
Ithaca, NY 14853
United States
607-255-7966 (Phone)
607-255-9984 (Fax)
HOME PAGE: http://www.people.cornell.edu/pages/sk145/
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Institute for the Study of Labor (IZA)
P.O. Box 7240
Bonn, D-53072
Germany
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