The impacts of trade liberalization on informal labor markets: A theoretical and empirical evaluation of the Brazilian case

• Published in: Journal of international economics Vol. 92; no. 2; pp. 330 - 348
• Main Author: Paz, Lourenço S.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-03-2014; Elsevier Sequoia S.A
• Subjects: Brazil; Economic impact; Employment; Informal economy; Informal labor markets; Labor market; Payroll tax; Studies; Tariffs; Trade liberalization; Brazil; O17; Brazil; Trade liberalization; H2; F1; Informal labor markets; Payroll tax; O54
• ISSN: 0022-1996; 1873-0353
• DOI: 10.1016/j.jinteco.2013.12.002

Following trade liberalization, several developing countries experienced a sharp increase in the share of informal manufacturing employment. In this paper, I examine the impacts of trade liberalization on the labor markets of a small open economy, in an environment in which tariffs affect firms' payroll tax compliance decisions. I demonstrate that a reduction in domestic import tariffs reduces the average formal wage and show that the direction of the effect on the share of informal employment depends on the initial labor market conditions. A cut in trading partner import tariffs decreases the share of domestic informal employment and increases the average formal wage. I confirm the model's principal findings empirically, using data from the 1989–2001 Brazilian trade liberalization episode. I find the results robust to endogeneity and self-selection concerns, which are addressed, respectively, using instrumental variable and switching regression approaches.
•I assess the effects of the Brazilian trade liberalization on informal workers.•I present a theoretical model of a small open economy with informal labor markets.•A tariff cut increases mildly informality share and average informal wage.•A tariff cut reduces average formal wage. Foreign tariff has the opposite effect.•Decreasing foreign tariffs decreases informality share and average informal wage.