The Formal Sector Wage Premium and Firm Size for Self-Employed Workers

41 Pages Posted: 16 Jun 2012

See all articles by Olivier Bargain

Olivier Bargain

IZA Institute of Labor Economics; University College Dublin (UCD)

Eliane Badaoui

University of Cergy-Pontoise - THEMA

Prudence Kwenda

University College Dublin (UCD)

Eric Strobl

Ecole Polytechnique, Paris - Department of Economic Sciences; IZA Institute of Labor Economics

Frank Walsh

National University of Ireland - University College Dublin

Abstract

We develop a model where formal sector firms pay tax and informal ones do not, but informal firms risk incurring the penalty associated with non-compliance. Workers may enter self-employment or search for jobs as employees. Workers with higher managerial skills will run larger firms while workers with lower will manage smaller firms and will be in self-employment only when they cannot find a salary job. For these workers self-employment is a secondary/informal form of employment. The Burdett and Mortensen (1998) equilibrium search model turns out to be a special case that we amend by incorporating taxes and a penalty for non-payment of taxes. Our model is also consistent with some of the empirical literature in that the informal wage penalty does appear to be limited to low wage/skill workers while firm size is an important determinant of the employee formal sector premium. We test theoretical predictions using empirical evidence from Mexico and find that firm size wage effects for employees and self-employed workers are broadly consistent with the model.

Keywords: informality, self-employment, Burdett and Mortensen model

JEL Classification: J31, O17

Suggested Citation

Bargain, Olivier and Badaoui, Eliane and Kwenda, Prudence and Strobl, Eric and Walsh, Frank, The Formal Sector Wage Premium and Firm Size for Self-Employed Workers. IZA Discussion Paper No. 6604, Available at SSRN: https://ssrn.com/abstract=2085191

Olivier Bargain (Contact Author)

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

University College Dublin (UCD) ( email )

Belfield, Dublin 4 4
Ireland
+353 1 716 8357 (Phone)
+353 1 283 0068 (Fax)

HOME PAGE: http://www.ucd.ie/economics/staff/obargain/obargain.htm

Eliane Badaoui

University of Cergy-Pontoise - THEMA ( email )

33 boulevard du port
F-95011 Cergy-Pontoise Cedex, 95011
France

Prudence Kwenda

University College Dublin (UCD) ( email )

Belfield, Dublin 4 4
Ireland

Eric Strobl

Ecole Polytechnique, Paris - Department of Economic Sciences ( email )

Ecole Polytechnique
Department of Economics
Paris, 75005
France

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Frank Walsh

National University of Ireland - University College Dublin ( email )

Department of Economics
Belfield
Dublin 4
Ireland
353-1-7068697 (Phone)
353-1-2830068 (Fax)

HOME PAGE: http://www.ucd.ie/~economic/staff/fwalsh/

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