Labor Productivity Growth, Informal Wage and Capital Mobility: A General Equilibrium Analysis

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1 See discussions, stts, nd uthor profiles for this publiction t: Lbor Productivity Growth, Informl Wge nd Cpitl Mobility: A Generl Equilibrium Anlysis Article September 2007 Source: RePEc CITATION 1 READS 27 2 uthors, including: Sibl r Centre for Studies in Socil Sciences, Clcutt 101 PUBLICATIONS 320 CITATIONS SEE PROFILE Avilble from: Sibl r Retrieved on: 12 My 2016

2 Published in: Rvi nbur nd Jn Svejnr (Eds.) Lbour Mrkets nd Economic Development, N: Routledge, And, Interntionl Policy Centre, University of Michign Working Pper # 54, Lbor Productivity Growth, Informl Wge nd Cpitl Mobility A Generl Equilibrium Anlysis Sugt Mrjit* Centre for Studies in Socil Sciences, Clcutt, Indi Sibl r Centre for Studies in Socil Sciences, Clcutt, Indi April 2007 Revised October 2007 Abstrct: The recent growth experience in Indi highlights the role of skill-bsed service sector nd productivity improvement rther thn significnt rise in physicl cpitl ccumultion, which hs only reched new height very recently. In this context we study the possible impct of higher productivity of lbor in the forml sector on the informl wge in n economy comprising of skilled nd unskilled workers. More productive skilled workers depress informl wge in the short-run, but do not ffect it in the long run, when cpitl is fully mobile cross sectors. If the productivity of unskilled workers in the forml sector improves, it my hve drsticlly different impct on the informl wge in the short nd the long run. Seculr lbor productivity growth in the informl sector my led to lower wge for informl workers if cpitl mobility is restricted between the forml nd the informl. However, with full mobility of cpitl this will not be n equilibrium outcome. eywords: skilled lbor, productivity growth, informl wge, fctor specificity JEL Code: J40, O1, O Corresponding uthor: Sugt Mrjit Centre for Studies in Socil Sciences, Clcutt. R-1, B.P. Township, kolkt , Indi. Ph Fx E-mil: smrjit@hotmil.com Acknowledgement: An erlier version of this pper ws presented t the Cornell-Michign Conference on Lbor Mrket in Trnsition nd developing Economies t the University of Michign, Ann Arbor. The uthors re indebted to conference prticipnts, in prticulr Rvi nbur nd Jn Svejnr nd to Ronld Jones for helpful comments. We re lso indebted to Prnb umr Ds for suggestions with the empiricl section. Reserch ssistnce by Mhswet undu nd Archit Bnik is lso cknowledged. The usul disclimer pplies.

3 1 1. Introduction This pper looks t the impct of growth in the productivity of workers in both the forml nd informl sectors, on the informl wge nd employment. It is now more or less estblished tht the recent surge in the Indin growth rte is much more relted to productivity boost thn to rise in investment (see for exmple, Guh-hsnobis nd Bri 2003; Mrjit, 2005, etc.). If such income growth precipittes on the lower deciles of the income groups, then it is expected tht the socil consequences of the overll increse in the growth rte must be reflected on the qulity of life of the poor people. It is clerly difficult tsk to mesure such impct t the micro level nd in terms of the vrious indictors of humn development, nd therefore, we rgue tht the informl wge is good indictor to cpture the income element, given tht most of the workforce in Indi is bsorbed in this segment. Hence, for exmple, one my like to know how productivity growth in the skilled sector ffects the wge of unskilled workers involved in the informl sector, or how productivity growth of unskilled workers working in the orgnized/forml sector ffects their informl counterprt. Before we provide further detils on the pln of work, let us briefly visit the existing literture deling with informl lbor mrkets in developing countries. Severl empiricl ppers by Mrjit nd Miti (2006), Sinh nd Adm (2006), Olofin nd Folwewo (2006) contined in recent volume edited by Guh-hsnobis nd nbur (2006) discuss vrious spects of the informl lbor mrkets nd its role in the development process. Goldberg nd Pvcnik (2003) nd Mrjit, Ghosh nd Bisws (2006) point out the symmetric impct of reform policies on the size of the informl sector. Mrjit (2003), Mrjit, r nd Beldi (2007) rgue tht liberl trde policies tht contrct the size of importcompeting sector nd crete excess supply of workers in the informl segment cn still led

4 2 to rise in the informl wge if cpitl is lso llowed to relocte to the informl sector. Empiricl evidence supporting these clims is provided in Mrjit nd r (2005) nd Mrjit nd Miti (2006). The theoreticl structure deling with forml-informl interction in some of the bovementioned work cptures dul lbor mrket by including high fixed wge forml sector with lower flexible wge informl segment, in line with the erlier tretments of Crruth nd Oswld (1981), Agenor nd Montiel (1997), Mrjit (2003) etc. While the min focus of the erlier ppers ws to investigte the trde policy induced reltive price effects on rel informl wge, the current pper highlights the productivity issue explicitly. It finds tht the degree of cpitl mobility between the forml nd the informl sector is quite criticl in determining whether the benefit of productivity growth in the forml sector percoltes to the informl workers nd/or whether productivity growth of the informl workers is eventully trnslted into n increse in their wge. In the process, we extend Jones (1971) nd demonstrte tht the condition under which the mobile fctor gins from its own productivity growth is ltered s soon s we bring in some degree of mobility in model where cpitl is sector-specific. The spillover effects of productivity growth on informl wge my perhps be best understood by dwelling upon the spects of free mobility of lbor nd cpitl, nd on the verticl linkge between the forml nd the informl sectors, of which we focus on the issue of fctor mobility only. The linkge effect is discussed in the ppendix. These, however, need to be supplemented by demnd side effects when growth in income spills over to the non-trded informl ctivities. et, we look t the supply side effects only, prtly becuse the demnd effect is quite stndrd nd lso due to the fct tht the demnd effect my not be very significnt.

5 3 In recent pper, Foster nd Rosenzweig (2004) rgue tht greter griculturl productivity induced higher wge in the rurl economy increses the cost of production in rurl industries. At the sme time, greter demnd for rurl non-trded goods encourges rurl industriliztion. In cse of Indi, the mix of such effects hs worked ginst rurl industriliztion. Thus, they show tht the role of demnd in rurl industriliztion is less significnt compred to the supply side effects. While the overll demnd effect in the entire economy cnnot be undermined, in the current context we re interested in identifying the supply side outcomes. In fct, using these elements s building blocks, our study offers generl equilibrium model of production for smll open economy nd looks t the lbor productivity growth in forml nd informl sectors. We derive set of results, by considering the short run when cpitl is sector specific, nd the longer run when cpitl moves grdully cross sectors. Higher productivity growth in the skilled sector in the short-run hs n unfvorble impct on the informl wge, wheres in the longer run, it my not hve ny impct. Productivity growth in the unskilled sector is likely to hve opposite effects on informl wge in the short nd in the long run. Productivity growth in the informl sector will be retined in higher wges in the short run provided Jones s (1971) condition holds. As we introduce some degree of cpitl mobility, the condition chnges nd the possibility of rising informl wge is eventully gurnteed by higher elsticity of cpitl mobility. With full mobility of cpitl the informl wge must rise. The pper is structured s follows. The second section offers the bsic frmework nd results. The third section ttempts simple econometric exercise to corroborte some of the theoreticl clims. The lst section concludes.

6 4 2. The Model We hve three sector economy, X uses skilled lbor nd cpitl; uses unskilled lbor nd cpitl. X nd re produced by the forml/orgnized segment of the lbor mrket. While the skilled wge is mrket determined, unionized brgining determines the level of fixed wge for the unskilled in the forml sector. One point should be noted here. One cn esily endogenize the fixed wge by invoking utility mximizing union without ny perceptible chnge in the direction of the results. Thus exogeneity of fixed unskilled wges is not crucil ssumption nd cn be relxed. is produced with informl workers nd cpitl. Informl wge is mrket determined nd is less thn the fixed wge in the forml sector. In the short term cpitl does not flow between the forml nd the informl segments. But there is perfect mobility of cpitl within the forml sectors producing X nd. Mrkets re competitive nd technology is neo-clssicl. We ssume exogenously given commodity prices, consistent with the smll open economy ssumption. Following equtions describe the model: The competitive price conditions re given by: w r P (1) S SX X X w r P (2) w R P (3) nd, the full employment conditions imply: X X ~ (4) L (5) SX X S (6)

7 5 (7) Note tht. Equtions (1) nd (2) determine w S nd r. Then from (4) nd (6) we determine X nd. Further, (3), (5) nd (7) determine w, R nd. ( X, SX,, ) re determined by the wge-rentl rtios, w w S nd. It is esy to check tht for (5) nd r r (7) to hold simultneously n increse in w must increse R s well. A rise in w, given, reduces demnd for lbor in the informl sector. Hence, R must rise to bsorb the excess. On the other hnd (3) suggests tht (w, R) should be negtively relted. These reltionships together nlyticlly determine w nd R nd hence from (7) (see Figure 1). w F C w* F C R* Figure 1 R Note: CC refers to the Competitive Condition, FF refers to the Full- Employment Condition.

8 6 This structure refers to the short-run with no mobility of cpitl between the forml nd the informl segment i.e. r R. We now look t the consequence of seculr decline in, nd SX on w, the informl wge. Note tht ws f t r SX, (8) where, t denotes some sort of productivity prmeter nd α < 0, denotes the elsticity SX of SX with respect to t given w S. r Let us trce the generl equilibrium consequence of drop in SX. A decline in SX w S must increse s r is pegged from (2). Note tht this should rise X nd reduce. From (5) it is strightforwrd to rgue tht there will be n excess supply of lbor in the informl segment following production contrction in. Thus w will go down nd R will increse. The size of informl output nd employment will expnd but informl workers will be poorer. A seculr decline in on the other hnd, rises r nd squeezes down w, reducing X nd incresing. Interestingly, lthough this my or my not increse the demnd for informl lbor s drops nd increses. If the elsticity of fctor substitution is strong enough, employment in will increse drwing workers from the informl segment. This should rise w nd reduce R in turn. The lst exercise, we dwell upon is the direct effect of seculr decline in on w. Given, whether such chnge increses w depends on the elsticity of substitution. With wek substitution elsticity wge cn go down. S

9 7 Note tht while productivity growth in the skilled sector cnnot increse w, more productive unskilled workers in the forml sector my rise w. The Long Run Suppose cpitl cn move freely between the forml nd the informl sectors with r R. Also equtions (4) nd (7) re now lumped together s (9). X (9) X Note tht w is insulted from chnges in supply of informl workers s cpitl moves in nd out to remove ny gp between r nd R. A drop in now increses w without ny impct on r or w. The short- run negtive SX S effect on w is now mitigted by the full mobility of cpitl, s X drws in the retrenched cpitl out of. On the other hnd, drop in will increse r, reduce both w nd w. The informl sector nd the skilled sector both hve to ccommodte higher r in the process. S Finlly, drop in must increse w. This is lso n unmbiguous result. As w is frozen, ny tendency of incresing the return to cpitl in the forml sector is countered by the movement of cpitl into the sector. Thus, the benefit rests with the informl workers. In fct, the rte of increse in w will be greter thn the rte of growth in productivity. 3. A Heuristic Exercise In this section, we try to ssess the bove theoreticl conjectures in terms of some empiricl evidence drwn from the dt on informl wge, forml sector productivity nd cpitl ccumultion in Indin industries. As noted in the theoreticl section, lbor productivity growth in the skilled sector should not benefit the informl workers. In fct, it cn

10 8 worsen if cpitl is sector- specific. On the other hnd, lbor productivity growth in the unskilled segment my increse unskilled informl wge. In terms of preliminry empiricl exercise we use dt on informl wge, lbor productivity in the orgnized sector nd fixed ssets for the unorgnized mnufcturing for vrious NSS (Ntionl Smple Survey of Indi) round between nd cross vrious provinces in Indi. We first construct n index to clssify the provinces ccording to the skill content in their orgnized production system, i.e., the sttes re clssified s reltively skilled nd reltively unskilled in terms of the prticiption of skilled workers in the orgnized mnufcturing within ech stte. The number of skilled workers in ny stte is obtined by tking the difference between the totl employees cross ll industry types less the number of wge erners in tht stte. The degree of skill concentrtion in ech stte my therefore, be simply stted s the shre of skill in totl employment. 1 Furthermore, the sttes hve been rnked s High Concentrtion (Rnk 1) or Low Concentrtion (Rnk 2) s per the respective skill concentrtions greter thn or less thn the ll-indi verge given in the lst but one column in Tble A1. Interestingly, most of the sttes do not disply ny pprecible increse in the skill concentrtion, nd some hve ctully registered lower skill concentrtion despite continuing bove the ntionl verge during the period ( to ). Using this informtion, we construct Skill-Dummy for ech stte (vlue 1, if skill concentrtion rtio bove ntionl verge, or vlue 0, if skill concentrtion rtio below it). Subsequently we run set of pooled regressions with rel informl wge (mnufcturing) s the dependent vrible. The dt is vilble from the three rounds of NSSO, i.e., , nd (see Appendix 3). The gross vlue dded (GVA) per worker in the orgnized mnufcturing s vilble from the Annul Survey of Industries for vrious sttes, the rel fixed ssets in the informl sector (vilble from 1 See Tble A1 in Appendix III for rnking of the sttes ccording to skill concentrtion s defined here.

11 9 NSSO) s proxy for cpitl stock nd the skill dummy s three explntory vribles. The GVA per worker in this structure represents the verge productivity of lbor in ech stte. The ctul vlues of GVA per worker, the level of rel informl fixed ssets nd the rel informl wge re shown in Tble A2 in Appendix III. The regression result offers n interesting, though explortory, evidence on the reltionship between nnul growth of rel informl wge nd the growth in GVA per worker in the forml sector. For the reltively unskilled sttes (i.e., for skill dummy tking vlue 0), the reltionship is positive nd significnt. However, the coefficient of rel fixed ssets is not significnt. On the other hnd, growth in the productivity of unskilled workers in the orgnized sector does hve positive influence on the growth of rel informl wge, distinct possibility in our theoreticl structure. 4. Concluding Remrks This pper strts from stylized fct tht the recent growth in the Indin economy is influenced more by productivity tke-off s compred to other fctors. Such productivity growth is lrgely concentrted in the service sector, which hs grown phenomenlly over the recent yers. However, given the fct tht the size of the unorgnized sector is quite substntil, number of interesting questions require serious ttention. As lbor productivity in the forml/ orgnized sector increses, does it help the informl workers? How does informl wge, benchmrk yrdstick for the poor, respond to such chnges in the shortrun nd in the long- run when we ccount for both lbor nd cpitl movement cross sectors? We prove tht higher productivity of skilled workers should not ffect informl wge. More productive unskilled workers in the forml segment my help the informl workers in the

12 10 short- run but definitely not in the long- run. Thus cpitl mobility plys crucil role in our nlysis, when spects of product mrket reform, productivity chnge, nd trde relted reform lso ffect the informl wge. We hve rgued elsewhere tht trde reform should help the informl workers provided cpitl moves more or less freely between the segments. But s we show here, the productivity impct does hve opposite implictions. For exmple, ny reform tht reduces the cost of cpitl in the forml sector must help the informl segment when cpitl is mobile. However, under the sme circumstnces productivity growth in the forml sector will hurt the informl workers. One future tsk might be to isolte these impcts empiriclly.

13 11 Appendix I Effect of decline in nd with imperfect mobility of cpitl ( ) R r X ~ ~ ~ (1A) (2A) (3A) Differentiting full- employment conditions (4A) (5A) (6A) (7A) 0 ~ 0 X X X β α From (2A), (4A), (5A), (6A) nd (7A) β α β α LX y R w r s R w r ) ( ) ( ) ( ~ (8A) Differentiting competitive price conditions, ( ) β α β α β α β w f w r ) (

14 12 From (3A) f 1 α β w α β w α β w f 1 α f 1 β f 1 f f α 1 1 w β (9A) f f ( ) ( ) 1 1 Suppose 0, α > 0, β 0 (Short Run, only Lbor Productivity in goes up). Then w > 0 iff 1 < Similrly for 0, α 0, β > 0, w > 0 iff 1 <. Thus strong elsticities of substitution will increse w. Let us divide the numertor nd denomintor in RHS of (9A) by 0 Then let (The perfect mobility cse)

15 13 α > 0, β 0 w < 0 α 0, β > 0 w > 0 This proves the rgument in the text. Appendix II Verticl Linkge nd Productivity Impct We follow Mrjit (2003). w r P m my P y (10A) w Lm r m P m (11A) w r P (12A) M is cpitl- intensive. In this model r is positively relted to P m s M is cpitl intensive nd LHS in (10A) is n incresing function of P m. Therefore, drop in must rise Pm nd r reducing w the sme effect tht we derive in the model without verticl linkge. If M is lbor intensive, r is declining in P m. In tht cse, one does not know whether the LHS in (10A) is declining in P m. If it is still incresing in P m, then drop in will rise Pm nd w vi the Stolper- Smuelson result. So, we do hve different outcome. However, if LHS in (10A) is declining in P m, drop in will reduce Pm nd w.

16 14 Appendix III Sttes Tble A1 Skill Concentrtion (Rnk) HIMACHAL PRADESH (1) (1) (1) MADHA PRADESH (1) (1) (1) DELHI (1) (1) (1) MAHARASHTRA (1) (1) (1) ARNATAA (1) (1) (1) HARANA (1) (1) (1) ORISSA (1) (2) (2) RAJASTHAN (1) (1) (1) WEST BENGAL (2) (2) (2) BIHAR (2) (2) (2) PUNJAB (2) (1) (2) GUJARAT (2) (1) (1) UTTAR PRADESH (2) (2) (1) TAMIL NADU (2) (2) (2) ERALA (2) (2) (2) ASSAM (2) (2) (2) ANDHRA PRADESH (2) (2) (2) All-Indi Averge Source: ASI, vrious yers Pooled regression results Pooled Regression Eqution (Rndom Effects Model): Ln ( I w) α ( β1 γ 1Ds ) Ln( F ) β2ln( I FA such tht, Ln ( I w ) 0.07 (0.61* 0. DS ) Ln( F ) 0.11Ln( I FA ) R-squred: 0.33, Adj. R-Squred: 0.29, Prob >F0.00, ρ 0, Husmn 0.00, * significnt t 5% level Where, I w Informl wge α Constnt Forml Averge Productivity of Lbor F )

17 15 I FA Informl fixed ssets D S Skill dummy (Which tkes vlue1 for skilled forml lbor, vlue0 for unskilled forml lbor) Tble A2: Stte-wise Rel GVA/worker, Rel Fixed Assets nd Rel Wge (Informl) Sttes Rel GVA per worker (Forml) Rel Fixed Assets ( 000) (Informl) Rel wge (Informl) ANDHRA PRADESH ASSAM BIHAR GUJARAT HARANA HIMACHAL PRADESH ARNATAA ERALA MADHA PRADESH MAHARASHTRA ORISSA PUNJAB RAJASTHAN TAMIL NADU UTTAR PRADESH WEST BENGAL DELHI

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19 17 Mrjit, S., S. Ghosh nd A.. Bisws (2006): Informlity, Corruption nd Trde Reform, Europen Journl of Politicl Economy (Forthcoming). Olofin, S. O., nd A. O. Folwewo (2006): Skill Requirements, Ernings nd Lbor Demnd in Nigeri s Urbn Informl Sector in Bsudeb Guh-hsnobis nd Rvi nbur (eds) Informl Lbor Mrkets nd Development, N: Plgrve- Mcmilln. Sinh, A., nd C. Adm (2006): Trde Reforms nd Informliztion: Getting Behind Jobless Growth in Indi in Bsudeb Guh-hsnobis nd Rvi nbur (Eds.), Informl Lbor Mrkets nd Development, N: Plgrve- McMilln.