Labor Market Rigidities and Informality in Colombia

Informality is at the center of the economic debate in Colombia, fueled by the high level prevalent in the country and its substantial increase during the 1990s. We study the effect of labor market rigidities, namely the increase in non-wage costs and the minimum wage on the size of the informal sector, the transition into and out of informality, and wages. Our results indicate that rises in non-wage costs and the minimum wage, increase the probability of transition into informality as well as the size of the informal sector. The business cycle has second order effects. The analysis across education groups points towards strong exclusion motives for low skilled informal workers, mainly driven by labor demand adjustments in response to increasing hiring costs; and argues somehow in favor of exit motives for workers with higher educational attainment. In addition, we document facts regarding the evolution and characteristics of the informal sector across alternative definitions of informality.