Firm‐Size Wage Gaps Along the Formal‐Informal Divide: Theory and Evidence

32 Pages Posted: 21 Mar 2016

See all articles by Binnur Balkan

Binnur Balkan

Stockholm School of Economics; Government of the Republic of Turkey - Central Bank of the Republic of Turkey

Semih Tumen

TED University; IZA Institute of Labor Economics

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Date Written: April 2016

Abstract

Observationally equivalent workers are paid higher wages in larger firms. This fact is often called the “firm‐size wage gap” and is regarded as a key empirical puzzle. Using microlevel data from Turkey, we document a new stylized fact: The firm‐size wage gap is more pronounced for informal (unregistered) jobs than for formal (registered) jobs. To explain this fact, we develop a two‐stage wage‐posting game with market imperfections and segmented markets, the solution to which produces wages as a function of firm size in a well‐defined subgame‐perfect equilibrium. The model proposes two explanations. First, taxes on formal employment generate a wedge between formal and informal size wage gaps. Thus, government policy can potentially affect the magnitude of the firm‐size wage gaps. The second explanation features a market‐based framework with strategic interactions. Relative to small firms, large firms typically post higher wages for both formal and informal jobs. A high‐wage formal job attracts a larger pool of applicants than a high‐wage informal job. The larger pool of applicants for the formal job, in turn, allows the firm to somewhat lower the initial wage offer, while this second‐round effect is negligible for informal jobs. As a result, size differentials are lower in formal jobs than informal jobs. We argue that the observed patterns in the use of social connections in job search and heterogeneity in job preferences can be used to justify the validity of this second mechanism.

Suggested Citation

Balkan, Binnur and Tumen, Semih, Firm‐Size Wage Gaps Along the Formal‐Informal Divide: Theory and Evidence (April 2016). Industrial Relations: A Journal of Economy and Society, Vol. 55, Issue 2, pp. 235-266, 2016, Available at SSRN: https://ssrn.com/abstract=2752168 or http://dx.doi.org/10.1111/irel.12135

Binnur Balkan (Contact Author)

Stockholm School of Economics ( email )

P.O. Box 6501
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S-113 83 Stockholm
Sweden

Government of the Republic of Turkey - Central Bank of the Republic of Turkey ( email )

Istiklal Cad. 10 Ulus
06100 Ankara, Ankara 06050
Turkey

Semih Tumen

TED University ( email )

Ziya Gokalp Bulvari No: 48
Kolej Çankaya, Ankara 06420
Turkey

IZA Institute of Labor Economics ( email )

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

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