Government Effectiveness and Regional Variation in Informal Employment

This paper analyses the role of government effectiveness in the determination of informal employment. A theoretical model is developed, in which local governance and worker skill level are assumed to influence the decision of the worker whether to seek employment in the formal or informal sector. The model is assessed empirically using data from Brazil, where almost half of the urban labour force is employed informally. The empirical analysis supports the predictions of the model and suggests that informal employment is lower in regions with better governance and higher average education.