Labor productivity growth, informal wage and capital mobility: A general equilibrium analysis

The recent growth experience in India highlights the role of skill-based service sector and productivity improvement rather than a significant rise in physical capital accumulation, which has only reached a new height very recently. In this context we study the possible impact of higher productivity of labor in the formal sector on the informal wage in an economy comprising of skilled and unskilled workers. More productive skilled workers depress informal wage in the short-run, but do not affect it in the long run, when capital is fully mobile across sectors. If the productivity of unskilled workers in the formal sector improves, it may have drastically different impact on the informal wage in the short and the long run. Secular labor productivity growth in the informal sector may lead to lower wage for informal workers if capital mobility is restricted between the formal and the informal. However, with full mobility of capital this will not be an equilibrium outcome.