SSRN Id968655bc

MPIA Working Paper
2007-09
The Urban Informal Sector and Poverty :

Effects of Trade Reform and Capital
Mobility in India
Sugata Marjit
Saibal Kar
March 2007
Sugata Marjit (Centre for Studies in Social Sciences,

Calcutta)
[email protected]
Saibal Kar (Centre for Studies in Social Sciences, Calcutta)
[email protected]
IDRC photo: N. McKee
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ABSTRACT
Studies on formal-informal interactions in the labor markets of developing countries
claim that economic reform increases the level of informal activity. Although the extent of
such claims differs across countries, it is generally believed that reform is likely to depress
informal wage by contracting the formal sector and driving labor onto its informal
counterpart. However, available empirical evidence suggests that real wage and real fixed
assets in the informal manufacturing sector have risen significantly across most states in
post-liberalization India. Using this as a benchmark, we formalize a general equilibrium
model of inter-sectoral capital mobility and informal wage to argue that, with limited degree
of capital mobility, trade reform reduces the informal wage. This is the conventional wisdom
usually obtained under a partial equilibrium framework. However, with increased mobility of
capital this result is reversed. We offer detailed empirical evidence on the movements of real
wage in the informal sector in India and how this affects poverty at the state level. The basic
result on income mobility is corroborated by a primary survey in the province of West
Bengal, for which we offer descriptive analysis on household income levels in the province’s
informal manufacturing and service sectors.
Keywords: Informal Wage, Capital Mobility, Trade Reform, Poverty, India
JEL Classifications: F13, F16, O17, J21, J31
This work was carried out with the aid of a grant from Poverty and Economic Policy (PEP)
Research Network, financed by the International Development Research Centre (IDRC). Sugata
Marjit is indebted to seminar and conference participants at the Middle East and North Africa Unit
of the World Bank, Indian Statistical Institute, University of Sydney, CSSSC, Nobuhiro Kiyotaki,
Ronald Jones and Mukul Majumdar for comments. Saibal Kar thanks Ira Gang, Kunal Sen and
participants at ESRC Conference, UEA; PEP conferences in Colombo and Addis Ababa for
helpful comments. The usual disclaimer applies. 2
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1. Introduction
The purpose of this paper is to explore the analytical implications of liberal trade
policies on the real wage of informal workers. The term ‘informal sector’ as initially coined by
the International Labor Organization (ILO, 1972) refers to, ‘‘illicit or illegal activities by
individuals operating outside the formal sphere for the purpose of evading taxation or
regulatory burden.’’ It may alternatively be defined as ‘‘very small enterprises that use low-
technology models and do not refer to legal status’’ (Webster & Fidler, 1996). Although
dominantly, informal sector activity pertains to non-traded items in the economy - from small
retailers and street vendors to domestic helps - in many developing countries they produce
exportable and import-substitute goods either independently or through subcontracting with
the formal sector. In its own right, the informal sector has become an institution in all
developing and transition countries, generating with it various positive and negative
implications effects (For example, Davis, 2006 argues that division of labor becomes greater
than optimal in the presence of informal institutions, resulting in greater than optimal
complexity and higher growth in the economy).
On an average, about 70 percent of the labor force in the less developed countries
(LDCs) belongs to the informal sector. Data from Southeast Asian, East European, African,
and Latin American countries show varying rates of urban informal sector employment
ranging from 15 percent to 20 percent in Turkey and Slovakia to 80 percent in Zambia, and
even to about 83 percent in Myanmar. Moreover, considering the state of agricultural and
rural activities in these countries, it is quite apparent that the total share of the informal
sector in the economy as a whole would be very high (ILO, 1999). This is corroborated by
some other studies such as Turnham (1993), which provides evidence that in low-income
countries like Nigeria, Bangladesh, Ivory Coast, India, and elsewhere, the share of the urban
informal sector to the overall economy is at least as high as 51 percent. The informal labor
market, characterized by competitive wage formation rather than a unionized process of
negotiations, has subsequently emerged as an important institution in the entire developing
world. Agenor (1996) and references therein provide ample evidence testifying on the
predominance of informal labor markets in the entire developing world.
Alternatively, seen from the point of view of the ‘minimum wage’ earners, only 11
percent of Tunisia’s labor force is subject to minimum wage; in Mexico and Morocco, a
substantive number earns less than the minimum wage; in Taiwan, minimum wage is less
than half of the average wage, and so on (Agenor, 1996). Interestingly, in the so-called
informal sector many workers earn even less than the minimum wage, typically because the
existence of non-market clearing downward rigid wages along with other corporate taxes
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pushes many private firms to operate in the informal sector (see Gang and Gangopadhyay,
1990 for further discussion and evidence on this).
The case of India offers a glaring example in this context. An overwhelmingly large
proportion (approximately 93%) of the industrial and service sector workforce in India is
employed under informal arrangements. A substantial portion of such employment
opportunities is generated in the urban or semi-urban areas and, not surprisingly, a majority
of this workforce is economically marginalized. The high incidence of poverty among these
groups, exposure to difficult and hazardous working conditions, non-existent social security
or health benefit schemes other than poorly functioning state-provided medical facilities,
among other things, is quite common. Contrary to conventional belief, it is also witnessed
that despite economic prosperity private firms and recently even public organizations are
entering into informal employment contracts, where workers receive contractual tenures and
wages, with no access to various benefits that earlier generations of workers enjoyed. The
dwindling labor union presence in many institutions has also contributed strongly in favor of
such hiring practices.
While these refer to informal practices within the formal institutions, a larger group of
workers face more pervasive informalization, with enormous implications on aspects of
income volatility, poverty, and standard of living for all those inside and outside the informal
segment. Given the economic trends in most developing countries, it is inconceivable that
the size of the informal sector would shrink considerably below the existing level and
therefore, sustained improvements in the living standards of these groups can only be
brought about by capital accumulation, productivity gains, and wage increases in this sector.
While there are several mechanisms that can generate such positive economic
impact for the existing group, here we argue that one of the crucial factors in this category is
the degree of capital mobility between the formal and the informal sectors. The motivation
behind invoking the issue of capital mobility comes from the observation that several
developing countries have been experimenting with policies on trade reform for quite some
time, where the critical feature has been the contraction of the formal protected industries,
either via import liberalization or through state initiatives in withdrawing support from loss-
making public enterprises. This implies that a large amount of capital and labor that were
earlier part of these industries would now have to relocate to a more profitable venture. It
should be noted that in most of these countries, the vacuum left by the vanishing large-scale
public industries has been filled not by similar manufacturing units, but by a predominantly
service-oriented industrial structure which faces less stringent labor laws and industrial
regulations. Moreover, the new opportunities that have emerged in the so-called sunshine
industries are incapable of accommodating the retrenched capital and labor, a larger share

of which has hence been devoted to less formal applications. There may be several
explanations for this transition, among which include the fact that workers in typical import-
competing public or private enterprises would not find an easy access to the more formal
service industries. These require high-skilled professionals with certain technical expertise,
which the old industries rarely employed.
Furthermore, this would mean that an assessment of the success of trade reform in
poor countries is incomplete without an explicit account of the welfare of informal workers
and of capital owners who have relocated to riskier and supposedly more profitable
businesses. Obviously, the principal concern in this context is the economic return an
informal worker receives when more such workers are involuntarily retrenched from the
formal sector and crowd into the informal counterpart. In fact, a critical stance against
downsizing an artificially bloated and subsidized formal sector is supported by the argument
that such downsizing will drive labor into the informal sector, lowering wages and forcing
workers to survive in poorer working conditions. If one assumes diminishing marginal
productivity of labor, a larger work force, ceteris paribus, must mean lower real wage. This is
the usual partial equilibrium response one should expect. However, the general equilibrium
outcomes could be quite different. For example, if the displaced workforce is accompanied
by fresh investments in the informal sector, existing informal workers are likely to gain. In the
present paper, we argue why mobility of capital is essential for understanding fully the
implications of economic reform on the large informal sectors in the developing world. In
particular, this paper also tries to establish that, despite contraction of the formal sector and
relocation of labor into the informal segment, the informal wage can still rise if the degree of
capital mobility exceeds a certain critical level.
2. Literature Review and Specific Objectives

Both theoretically and empirically, this paper highlights the role of capital mobility
between the formal and the informal sectors in determining the direction of the informal
wage, when the formal segment is adversely affected by liberal trade policies. The
theoretical aspect offers distinct departures from the traditional literature that uses the
Harris-Todaro type structures to model the informal sector (for example, Fields 1975; Gupta,
1993, 1997; etc.) However, problems with the Harris-Todaro framework are now well known
(Basu, 1984; and Majumdar, 1976, 1983), and a major critique of the framework is that open
unemployment among the poor workers is far less plausible than conjectured, since
remaining unemployed for long involves severe costs for such groups. Therefore, it is quite
likely that they settle for any jobs, which are mostly located in the informal sector. When the
sector faces an excess supply of such workers, a crashing of wages (rather than
unemployment) is the more feasible outcome.

Using this very realistic phenomenon in the developing world, our theoretical
framework uses a full-employment model, where wage in the formal sector is set at a high
level by unionized bargaining while the informal segment faces a low flexible wage. The
theoretical inspirations behind this framework are drawn from Carruth and Oswald (1981),
Agenor and Montiel (1996), Kar and Marjit (2001), Marjit and Beladi (2002) and Marjit
(2003), etc.
Furthermore, unlike previous studies, here we bring in imperfections in the allocation

of existing stock of capital between formal and informal manufacturing. Albeit the informal
sector may not use up a vast amount of capital itself because of inadequate property rights
or due to the absence of contractual protections, there is evidence of some degree of inter-
sectoral mobility of capital.1. Essentially therefore, we model the mobility of capital explicitly,
which depends on return differential and the inability of capital to relocate affects the
accumulation process in the informal segment. If capital is guaranteed of a protected return
in the formal sector, it hardly has any reason to flow out to the informal sector. However, as
the protectionary shelter is withdrawn, capital relocates where it continues earning the
highest returns. In certain cases, such movements could be a lengthy process and quite
costly, depending on existing institutional arrangements.
The empirical basis of our theoretical work is drawn from the evidence on informal
wage and capital accumulation in the informal manufacturing sector in India. We use various
rounds (1984-85, 1989-90, 1994-95, 1999-00 and 2000-01) of National Sample Survey data
to demonstrate that: (1) the real informal wage for the non-directory manufacturing
enterprise (NDME) has increased between the pre-reform and the post-reform decades; (2)
real capital stock in the organized manufacturing has remained stagnant or declined in real
terms vis-à-vis real fixed assets in the informal sector, which has grown substantially in the
post-reform period; (3) for a majority of the states and union territories in India, the growth of
real informal wage is significantly explained by growth of real fixed assets and real value
added in the informal sector.
While we are not building up a model to explain the movement in the real informal
wage in India, our theoretical work highlights the case of rising informal wage in accordance
with a rising capital stock in the informal sector. We argue that if trade reform reduces the
output of the import-competing product and subsequently drives labor to the informal sector,
the informal wage tends to rise only when a ‘critical’ amount of capital also relocates to the
informal sector alongside labor. In a static general equilibrium model this is captured by a
1
Earlier, De Soto (1989) pointed out that a heavy burden of taxes, bribes and inflexible bureaucratic
regulations in the formal sector drives many producers into the informal sector; and similar arguments
in Gang and Gangopadhyay (1990).

greater allocation of capital in the informal sector and a simultaneous decline in the capital
stock in the formal counterpart. While direct empirical evidence can hardly capture this
mobility, we use proxy estimates to demonstrate that there have been phases in post-reform
India when capital in the organized manufacturing sector did not grow at all. However, during
the same periods, real fixed assets – a true measure of capital stock in the informal sector –
grew substantially. We use this evidence as a plausible foundation for our theoretical
propositions.
Our paper has a strong policy implication. If inter-sectoral capital flow is severely
restricted by institutional and other factors, downsizing of the formal segment will be harmful
to the vast majority of informal workers. Excess supply of labor in the informal sector must
be accompanied by adequate investments in this sector in order for informal workers to
benefit.
The rest of the paper is organized in the following manner. The third section develops
the theoretical model. The fourth offers empirical evidence on the direction and growth of
informal wage in India, while Section 5 provides implications for the state of poverty in
different Indian states. Section 6 concludes.
3. The model
We assume a two-sector small open economy. X is produced in the formal
manufacturing sector and Y is the informal manufacturing sector. Both X and Y use labor
and capital. Wage in the formal segment is fixed through bargaining. Initially, X is protected
either through a tariff or by a state subsidy, which artificially increases the price of X. Trade
reform or withdrawal of subsidy implies a decline in the tariff/subsidy rate, denoted by t.
Workers who do not find jobs in the formal sector flock in sector Y where they receive the
market determined wage rate. We call this the informal wage. There is no open
unemployment in this model. People must find jobs to survive, and wage in the informal
sector adjusts fully to accommodate workers moving into the sector. Markets are competitive
and technology exhibits CRS (constant returns to scale) and diminishing marginal
productivity.
The model is similar in spirit to Agenor and Montiel (1996), Carruth and Oswald
(1981), Marjit and Beladi (2002) and Marjit (2003). Capital and land are fully employed.
The symbols we use are given as follows:
w: Formal unionized wage; w: Informal (flexible) wage
ri : Return to capital in sector i; X: Output of formal sector;

Y: Output of informal sector ( PX , PY ) : Exogenous commodity prices
L: Supply of Labor; K: Total supply of capital
Ki : Supply of capital in sector i.; (aLX , aLY ) : Per unit labor use in X and Y.
(aKX , aKY ) : Per unit capital use in X and Y; t : Tariff rate or subsidy.
‘^’ represents percentage changes for particular variables, and symbols used bear the same
implications as in Jones (1965).
Competitive price equations that describe the system are given by,
w aLX + rX aKX = PX (1 + t ) (1)
waLY + rY aKY = PY (2)
Commodity prices are given from the rest of the world. Let us suppose Y is exported
and X is imported.
Full employment conditions imply:
aLX X + aLY Y = L (3)
K X + KY = K
(4)
aKX X = K X
(5)
aKY Y = KY (6)
Let ŵ be so determined that,
wˆ = αPˆX + βPˆY , 0 < α , β < 1 (7)
Finally, the capital mobility condition:
KX ⎛r ⎞
= φ ⎜⎜ X ⎟⎟,φ ′ > 0 (8)
KY ⎝ rY ⎠
Equation (8) suggests the following. At any point in time K is allocated between X
and Y. But such allocation depends on return differential. Hence there is imperfect mobility of
⎛ rX ⎞ KX KX
capital. If ⎜ ⎟ increases, will also increase. describes the relative supply of
⎝ rY ⎠ KY KY

capital in sector X. The usual way to model this is to assume sector-specific capital for X and
Y without any mobility, with φ ′ = 0 . Perfect mobility will always imply rY = rX and there is no
relevance for a separate sectoral supply function of capital. Relative supply adjusts to
demand in each sector, which is the standard Heckscher-Ohlin structure. We shall
demonstrate that our comparative static depends on the curvature of φ ′ = 0 .
Given ( PX + t , PY ) , w , L, and K, we have w, rX , rY , X, Y, K X , KY to solve from (1)-

(6) and (8). The determination of general equilibrium proceeds as follows. From (1) we can
determine rX . Now using (4) and (8) we get (8) ′.
K − KY ⎛r ⎞
= φ ⎜⎜ X ⎟⎟ (8)′
KY ⎝ rY ⎠
As rY increases, given rX and φ ′ > 0 , KY must rise. This defines the relationship
MM in figure (1). Now using (5), (6) and (3),
aLX a
( K − KY ) + LY KY = L (9)
aKX aKY
aLX rY
r a r
Since X is given by CRS, KX is given. Now as Y increases, from (2), w must
aLY
rise and aKY must rise as well. Hence in equation (9) the LHS unambiguously increases. To
aLY aLX
bring back the balance KY
a
must fall substantially. As long as aKY > KX , LHS must
decrease with a decline in KY . Such an assumption implies that the informal sector is labor-
intensive; an assumption by virtue of being realistic is kept all through the paper. Therefore
as rY rises, KY must fall. This defines FF in figure (1). Once ( rY , KY ) are determined from
Figure (1), the rest of the variables can be determined easily.
The key comparative static exercise we are interested in is a decline in ‘t’. Figure (1)
helps us to trace out the consequences of both. A decline in t reduces rX , given w and PX .
Given rY a drop in rX increases KY , as φ > 0 . This will mean a rightward shift of MM to

′
M ′M ′ .
aLX
At the same time given rY and KY , a drop in rX reduces and therefore LHS in
aKX
(9) declines. The balance is restored through an increase in KY at a given rY . FF shifts to

the right as well. The way figure (2) is drawn suggests that Y must expand. But rY may
remain unchanged and can in fact go either way. Note that if MM shifts quite a bit relative to
FF, rY will decline and w will increase. The mobility effect has to be significant for a positive
aLX
effect on the informal wage. A drop in releases labor to Y sector, which implies that FF
aLY
shifts up requiring more KY to accommodate displaced labor. Additional capital that comes
to Y because rX is lower must outweigh the required amount needed to absorb displaced
labor at a given rY , hence at a given w to induce an increase in w. With zero mobility MM is
vertical and remains unchanged. Hence, rY must increase and w must decrease through a
shift in FF. With perfect mobility MM is horizontal at rY = rX and as rX drops, MM shifts
down. Notwithstanding the shift in FF, rY must adjust to the new level of rX and w must
increase. Figure (3) describes the effects of such adjustments.
The above two cases explicitly demonstrate the partial and general equilibrium
results that can be derived from this model. In figure 2, the vertical line MM represents
perfect immobility of capital between the formal and the informal segments. Under the
circumstances, formal job losses and crowding in of workers into the informal sector leads to
wage cuts in the latter. The situation undergoes a complete reversal if capital is perfectly
mobile and is represented by a horizontal line MM (figures 2 and 3). Retrenchments from the
formal sector and additional job creation in the informal sector could even lead to a wage
gain for the informal workers, thus establishing the general equilibrium implications of our
model.
dw
Finally, the precise condition for > 0 is derived by following the above
dt
arguments. In fact, there is an increase in the informal wage if the following condition is
satisfied
⎛λ ⎞
wˆ > 0, iff , ε > σ X K X f ⎜⎜ LX ⎟⎟ . (10)2,3
⎝ λKX ⎠
2
See Appendix I for detailed algebraic proof.
3
Condition (10) offers a directly testable hypothesis. However, it requires matching data on product
specific capital stock in both formal and informal sectors, and the return such capital fetches in each
sector. Annual Survey of Industries in India offers data on formal commodities until 1997 only, and
reliable data on the return to capital in the informal sector is unavailable. Thus, we set aside this direct
exercise for a future effort and instead use a proxy measure for present requirements.
10

Figure 1
rY
M
F
r *Y
M F
KY
K *Y
Figure 2
rY M
F′ Zero Mobility
F M
M′
Perfect Mobility
r *Y
F′
M
M′ F
KY
M
Figure 3
rY
F′
F
M M
M′ M′
F F′
KY
11

4. Empirical Evidence for India
This section concentrates on the relationship between inter-sectoral capital mobility
and the real informal wage by looking at the available Indian data for the pre-reform (pre
1991-92) and post-reform periods. To this end we choose three factors that can potentially
explain the growth of informal wage for different states in India, namely, Real Fixed Asset
(FA) in the informal sector, Real Value Added (VA) in the informal sector and the Real Rural
Wage (RW). Previously, it has been discussed (Kar and Marjit, 2001) that the workers
migrating from the rural areas cannot afford to wait indefinitely in the urban sector for a
potential job opening, and instead join the urban informal sector for lower wages. When
wages are high in the rural area they tend to migrate back. Informal employment and thus
informal wage in the developing countries are strongly influenced by such seasonality of
rural-urban migration. We therefore use rural wage as an exogenous variable in explaining
trends in urban informal wage.
The empirical investigation involves a choice of five strategic time periods over the
last two decades in India. We begin by calculating the annual growth rates of informal real
wage and the explanatory variables between five data points: 1984-85, 1989-90, 1994-95,
1999-00 and 2000-01.4 Comparison between the first two data points gives us an idea on
the pre-reform growth rates. 1989-90 to 1994-95 mark the transition through the trade reform
period and 1994-95 to 1999-2000 capture the immediate post-reform situation. The period
between 1999-00 and 2000-01 is useful for observing the matured impact of trade reform on
informal wage. Unavailability of a continuous time series restricts our choice to this five-point
data set.
As already mentioned, we assume imperfect capital mobility between the formal and
the informal sectors, which essentially means that following a contraction in the formal sector
some capital may be relocated to the informal sector.5 In our example, the capital
reallocation occurs between the formal manufacturing sector and the non-directory
manufacturing enterprises in the informal sector.6 However, this is a proxy for measuring
4
Secondary data on Informal sector activities in India is available from intermittent (usually every five
year) sample surveys by NSSO (National Sample Survey Organization), Government of India.
5
Interest rate cuts in the commercial banks along with high volatility and lack of trust on the
functioning of the stock exchanges might have contributed substantially to such capital flight for
supporting informal activities. While this requires further evidence and more detailed analysis, it is
also believed that a large section of the retrenched labor has used their early retirement benefits and
severance pays as startup capital for small businesses. Undoubtedly further research is needed to
track the relocation path for such capital stock deterministically.
6
This is not to preclude the possibility that formal industrial capital may relocate to say, services
within the formal sector. However, the overwhelming fixed assets formation in the informal sector
along with falling capital stock in the formal suggests that a large portion of the investments previously
12

capital relocation between the sectors and we use the growth of real fixed assets in the
informal sector as an explanatory factor for growth of the real informal wage. Finally, we use
the real value added in the informal sector to see if that has sufficient explanatory power
behind increases in the real informal wage. Obviously, the starting point of this analysis is
the observation that the real informal wage has increased unambiguously in most states and
union territories7 in India, after the onset of trade liberalization. We provide this evidence in
table 1 (in Appendix II), initially for 15 major states and after 1989-90 for 30 states and union
territories. Finally, we check for existence of structural breaks between the pre and post-
reform periods for the annual growth rates in informal wage.
Following the plan of empirical study, we begin by providing observations on the

annual growth of real wage, real VA and real FA (in 1989 prices) for the informal sector as
well as that of the real rural wage across different states and union territories in India. Due to
incompleteness of the data, we calculate the real growth rates for only 17 states during
1984-85, and expand the set to include 30 states and union territories for 1989-90, 1994-95,
1999-2000 and 2000-01. Table 2 (Appendix II) offers detailed descriptive statistics for the
variables under consideration and Table 3 shows that any substantial problem of multi-
collinearity among the variables does not exist.
The first of the three explanatory variables, informal fixed assets (real FA) grew at a
temperate rate between 1984-85 and 1989-90 for many states (Fig. 5, Appendix II), although
the states of Assam (AS), Haryana (HY), Kerala (KE), Tripura (TR) and West Bengal (WB)
registered negative growth of informal real fixed assets during this period. However, during
1989-90 and 1994-95, immediately after the reforms took effect in India, informal fixed asset
shows high growth rate in many of the states. Once again, Bihar (BH), Himachal Pradesh
(HP), Lakshadweep (LA), Meghalaya (ME) etc., report negative growth. Between 1994-95
and 1999-2000 informal fixed assets grew positively (10% to 150%) for 29 out of 30
locations in India, with the exception of Manipur (MA). The pattern, however, seems
dampened for many states during 1999-00 and 2000-01.
The second explanatory variable real Value Added (VA) also registered a negative
trend for all states except Gujarat and West Bengal during 1984-85 and 1989-90. It
undergoes a turn around in the post reform period, when most states and union territories
show significant increase in the value added. Finally between 1999-00 and 2000-01 it
reports negative growth rates in many states.8
in the formal sector has flown in to the informal segment, especially when the total savings in India
has not changed significantly.
7
Regions directly administered by the central government.
8
Data and trends for this variable are available on request. We do not explicitly report them here.
13

Third, real RW denotes the real growth rate of rural wage. It shows negative growth
rates for all the states between 1984-85 and 1989-90, which change to positive growth rates
between 1989-90 and 1994-95 for majority of the states. However, this was not sustained,
since between 1994-95 and 1999-00 relatively more states like TR, Andaman and Nicobar
Islands (AN), SI, Jammu and Kashmir (JK) etc., once again record negative growth in rural
wage, which continues to later periods.
The dependent variable in our model, the growth rate of real informal wage (IW)
shows a negative growth for all the states between 1984-85 and 1989-90 (see Figure 4 and
Table 1). The trend shifted substantially in favor of informal workers in the period
immediately following the introduction of economic reforms in India. All the states including,
GJ, MH, OR (22%), TN, RJ (32%), AP (38%) showed significant positive annual growth in
informal wages. Between 1994-95 and 1999-00, twenty-nine out of thirty locations, except
WB (-2%) show moderate positive annual growth of informal wage and the post reform
average annual growth in informal wage is recorded at between 15-20 percent with a
variance of 26 percent between states.
Based on these observations, we offer results from a generalized least square

regression (Table 4), where real informal wage is regressed on real FA, real VA and real RW
after correcting for presence of heteroscedasticity in the error terms. Between 1984-85 and
1989-90 (denoted as 1989-90 in Table 4), all the elements significantly explain changes in
the informal real wage. Notably, the intercept term is negative. Admittedly, the explanatory
power of the regression (Adjusted R-squares) analysis declines over time and it is lowest for
the growth rates between 1994-95 and 1999-00, with the consequence that real VA alone is
capable of explaining positively and significantly the growth in real informal wage. One can
nevertheless observe from this cross-section that the informal wage has experienced shifts
in both direction and magnitude between pre-reform and post-reform periods, as have been
the factors deemed most responsible for its movements. For example, the growth in real
rural wage affects the real informal wage negatively (and significantly) in the last period,
unlike in the first three.
Subsequently, we offer a pooled (or a pseudo panel) regression for these variables
and report the findings in table 5. The panel regression initially tests for whether the fixed
effects (FE) or the random effects (RE) model is consistent with the data, given that the
FE/RE is the natural choice over the classical regression (CR) model since the value of the
Lagrange Multiplier is very large. Further, between FE and RE the results from the Hausman
Test suggests that FE is the appropriate model to use. Consequently, we use the
14

methodology of Least Squares Dummy Variables after correcting for heteroscedasticity.9
According to this model however, the real FA and real RW are not significant, although the
former shows a positive impact on real IW. On the other hand, real VA is positive and highly
significant (at 1% level) in explaining the increase in real IW. The added information that this
exercise offers is that, despite shifting importance attached to real FA and real VA in
explaining real IW as witnessed from the cross-section regression results, the general trend
seems to be that both real FA and real VA can explain growth in real IW positively. However,
it also appears that the negative impact of the rural wage as observed during the last growth
phase dominates the general trend.
Finally, we offer results from the investigation into the existence of structural breaks
in the real IW. To this extent, we use the standard Chow test and identify that there exists
multiple structural breaks over the entire span of the period, including 1994-95, 1999-00 and
2000-01 as the break years. Table 6 indicates that both the intercept and the slope have
changed significantly over time. The graphical representation of the nature of the changes in
the Annual Informal Wage Growth is given in figure 7. The graphical representation clearly
shows the jumps and changes in both intercepts and slopes as we have discussed above.
5. Impact on Impact on Poverty and Further Evidence from Primary Survey

This section reports one of the main results that has motivated the present exercise:
the relationship between changes in informal wage in the different states and union
territories in India and the changes in the percentage of people registered under the Below
Poverty Line (BPL) category. The argument follows from the hypothesis that a large part of
the urban poor in India works and lives in the so-called informal sector arrangements and
that any improvement in the conditions of the informal workers can leave a significant and
sustained impact on the incidence of poverty in the urban areas of the country. We
subsequently test for the relationship between Urban Head Count Ratio (HCR) and the level
of informal wage in the urban manufacturing units. The exercise is done in two stages: first,
we regress the current period’s BPL percentage on previous periods’ Annual Informal Wage
growth, where the results of the OLS suggest a negative relationship significant at 5 percent
level (Table 7, Appendix II). Second, we run the analysis as a panel of the states and union
territories, which reveals the presence of random effects and closely match that of the OLS
results. However, as shown in table 8, the coefficient of IWPREV (real informal wage in the
previous period) is still negative but now significant at 1 percent level. To summarize
therefore, one may state that the effect of an improvement in the annual wage growth in the
informal sector has negative and significant impact on the incidence of poverty across states
9
See Greene (2003) for details on the methodology.
15

and union territories in India as per the data on the BPL category. In the next section we
extend this analysis by considering the case of West Bengal.
The secondary evidence was corroborated by a primary survey spanning the

geographical boundaries of the state of West Bengal. A total number of 500 informal sector
units (Non-Directory Manufacturing units and Own Account Enterprise), in four major
industrial locations namely, Calcutta, Howrah, Durgapur and Siliguri, were surveyed in order
to investigate the nature of the transition in the informal sector over the last decade.
The data is collected through random sampling without replacement in the production
units in the four locations mentioned above. Since most such informal units in India operate
as household level trades, and resemble production organizations in agriculture, the
dependent variable in our regression is the ‘Average Household Income for the current
Period: 2000-05’ (Y). There are two primary dependent variables in this cross section
sample: ‘the average stock of capital ownership/fixed assets between 2000-05’ (C) and ‘the
per unit average price of the traded commodity between 2000-05’ (P).
The sample is quite heterogeneous by informal occupational types of the

respondents, and ranges from producers of iron safe, jewelry, machine tools, auto parts, to
the worst possible cases of very low-paid maid servants. The survey is designed to report
both manufacturing and own-account enterprises in roughly 60-40 ratios.
We begin by giving some descriptive analyses of the data on the four locations, but
for the sake of brevity we offer an example only.10 The method applied is the following: We
compare the household income of the respondents between pre-reform and post-reform
periods. Figure 7a for example, reports the average (for the year 1991-05) income
distribution in the city of Durgapur and is compared with that received on an average before
1991. It shows that 53 percent of households involved with informal manufacturing units earn
more in the post-reform period. Furthermore, if the comparison is that between the more
recent period 2000-05 and the pre-1991 era, 58 percent of households in this category have
been better off (Figure 7b). However, it is not self-evident from here that there is a one-to-
one correspondence with poverty, and that the improvement in household income
necessarily reduces poverty.
On the other hand, for the services category within the urban informal sector less
households seem to have registered income growth compared to the preceding five years
(see Figures 7c and 7d). We perform a similar exercise for Siliguri, Howrah, and Kolkata.
While Howrah displays similar experiences for households engaged with manufacturing units
in the informal sector, Kolkata and Siliguri show poor results for more recent periods for the
10
A detailed analysis and report on these patterns is available on the PEP website.
16

same category. In fact, the trend in the service sector is similar almost everywhere, where
the period ending in the year 2000 seems more prosperous than that ending in the year
2005.
Next we report the results from our regression analyses for the four locations under
review. Based on the explanatory variables discussed above we try to explain the changes
in the household income for these places. It is to be noted however that conditions in
Howrah have undergone such a rapid transformation that most respondents – be it in the
manufacturing units or in the service units – report little or no new capital expenditure for the
period between 2000 and 2005. We are therefore compelled to use the capital stock that
they report for the immediately preceding period as the explanatory variable in place of the
current capital stock that we use for all the other locations. The results are given in tables
11-14 in Appendix II. Interestingly, the level of current capital stock significantly explains the
positive surge in household income for most locations, although the price per unit turns out
to be a poor explanatory variable in predicting the same. Obviously, there is no direct
implication for the effect of household income on poverty for any of these locations. We use
the household income and its determinants as an alternative to explain if there has been any
transformation in the whole situation concerning the status of informal workers in the
manufacturing as well as in the services sector.
Thus, the results from the primary survey must be taken with caution in formulating
any policy measure towards improving the condition of informal workers in the state or in the
country. There is undoubtedly a need for further research in this category in favor of a
clearer understanding of the nature of transformation in the informal sector in general.
Nonetheless, the present study should serve as an important step in this direction not only
because of its broader view on the subject, but also because of its identification of such
aspects as capital mobility and its impact on informal wage, which had previously been
completely overlooked.
6. Concluding remarks
The purpose of this paper has been to look into the impact of trade reform policies on
informal wage in a typical developing economy. The fact that poor informal workers must find
employment for survival allows us to use a full-employment model in a general equilibrium
setting. By using a generalized theoretical construct we have proposed and demonstrated
that a crucial factor, which determines the wage-employment status of the existing informal
workers, is the degree of capital mobility between the formal and the informal sectors. As the
formal sector contracts due to tariff liberalization and retrenched workers crowd into the
informal sector for employment, informal wage does not necessarily fall. If capital also starts
17

moving into the informal sector, it is quite likely that informal wage will rise provided the
degree of capital mobility is not very low. This tends to go against the argument that more
employment in the informal sector signifies lower wage for the average informal worker. We
have characterized the cases with perfect and zero mobility of capital demonstrating two
extreme situations. Modeling the degree of capital mobility explicitly in an otherwise simple
general equilibrium structure clearly establishes the result.
The empirical section is however, not a direct test of the theoretical results for
reasons mentioned above. Instead, we use data from the informal sector in India to reflect
on the testable hypothesis in an exploratory sense. The informal sector in India has
registered an annual increase in real wages by 15-20 percent during the post-reform
decade. At the same time, there have been substantial increments in the real fixed assets
and real value added in the sector. We show that both these factors, as well as the real rural
wage in the country, explain growth in the real informal wage positively and significantly for
most of the time periods under consideration.
The accumulation of real fixed assets in the informal sector corresponds with
declining real capital stock in the formal sector, which in our case exemplifies the issue of
capital mobility discussed above. Interestingly, the growth of fixed assets in the informal
sector convincingly outweighs the growth of fixed capital stock in the organized sector in the
post-reform phase. In the absence of data on the path that each unit of capital follows as and
when relocated, this is used as a proxy measure.
The message that this study intends to drive at is simple and clear. If one has to
study the impact of reform on labor markets, one has to look at the working of the capital
market as well. While greater employment in the informal sector can be a sign of both
poverty and prosperity, the true outcomes are distinctly visible only when the role of the
capital market is also taken into consideration. To make the problem a meaningful exercise,
we checked whether a substantial rise in capital stock in informal manufacturing is consistent
with a phase of either a meager or a negative growth of fixed capital stock in the organized
manufacturing sector.
As an extension one could bring agriculture into the picture with mobile labor and
fixed supply of land. It is also possible to show how profitability in agriculture can influence
the informal wage with or without capital mobility, an exercise which is undoubtedly relevant
for the developing economies. Thus, the analysis should also be useful for cross-country
empirical studies in the future.
We have kept the commodity prices fixed by the small country assumption.
Alternatively, one can introduce a homothetic demand function and, with the elasticity of
18

substitution in demand crossing a critical threshold, all our results will hold. One may argue
that we have ignored the ‘non-traded’ characteristic of the informal sector. However, it
follows from our basic model that bringing in a second informal sector producing a non-
traded good does not add much to the results. If capital is highly mobile, tariff reform must
increase the informal wage and reduce the return to capital. The price of the non-traded
good can move in any direction. Finally, the impact on the informal wage should remain the
same, qualitatively.
References
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19

Marjit, S & H. Beladi, 2002, The Stolper-Samuelson theorem in a wage differential
framework, The Japanese Economic Review 53, 2, 177-181.
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Washington, DC: World Bank Regional and Sectoral Studies, World Bank.
20

Appendix I
Proof of condition (10)
w aLX + rX aKX = PX (1 + t ) (A.1)
waLY + rY aKY = PY (A.2)
KX ⎛r ⎞
= φ ⎜⎜ X ⎟⎟, φ ′ > 0
KY ⎝ rY ⎠
K − KY ⎛r ⎞
= φ ⎜⎜ X ⎟⎟ (A.3)
KY ⎝ rY ⎠
From (A.1), rˆX θ KX = PˆX − θ LX w

ˆ
= PˆX (1 − θ LX α ) (A.4)
ˆ = αPˆ + βPˆ = αP̂ , since Pˆ = 0 .

Where, w X Y X Y
θ KY
ˆ θ LY + rˆYθ KY = 0 . This implies, wˆ = −
From (A.2), w rˆY . (A.5)
θ LY
Now using equations (3) to (6),
aLX X + aLY Y = L .
aLX a
Reformulating, ( K − KY ) + LY KY = L
aKX aKY
Again, λLX Xˆ + λLY Yˆ + λLX aˆ LX + λLY aˆ LY = 0

And λLX Kˆ X + λLY Kˆ Y + λLX (aˆ LX − aˆ KX ) + λLY (aˆ LY − aˆ KY ) = 0 (A.6)
But, as K X = K − KY
Kˆ X = − Kˆ Y / φ , where φ = ( K X / KY ) .
Substituting these information in (A.6),
1
− λLX Kˆ Y + λLY Kˆ Y + λLX σ X rˆX − λLY σ Y ( wˆ − rˆY ) = 0 (A.7)
φ
Rearranging, and using (A.4), and θ LY ( wˆ − rˆ) = −rˆY

1 ⎛ 1 − θ LX α ⎞ rˆ
(λLY − λLX ) Kˆ Y + λLX σ X PˆX ⎜⎜ ⎟⎟ + λLY σ Y Y = 0 .
φ ⎝ θ KX ⎠ θ LY
1 λLY ⎛ 1 − θ LX α ⎞
Thus, (λLY − λLX ) Kˆ Y + σ Y rˆY = −λLX σ X PˆX ⎜⎜ ⎟⎟ (A.8)
φ θ LY ⎝ θ KX ⎠
Now, taking ‘ln’ on (A.3),
21

⎛r ⎞
ln( K − KY ) − ln KY = ln φ ⎜⎜ X ⎟⎟ . Taking percentage changes,
⎝ rY ⎠
1 1 δφ rY drX − rX drY φ ′ rX
Kˆ X − Kˆ Y = dφ = = (rˆX − rˆY ) . Using (A.4),
φ φ ⎛ rX ⎞ rY2 φ rY
δ ⎜⎜ ⎟⎟
⎝ rY ⎠
φ ′ rX φ ′ rX ˆ
or, Kˆ X − Kˆ Y + rˆY = [ PX (1 − θ LX α ) / θ KX ]
φ rY φ rY
δφ rX / rY
We define, ε = , as the elasticity of capital mobility between sectors X and Y.
δ (rX / rY ) φ
1
Thus, − Kˆ Y [1 + ] + ε .rˆY = εPˆX (1 − θ LX α )
φ
1 1
Therefore, rˆY = Kˆ Y [1 + ] + PˆX (1 − θ LX α ) (A.9)
ε φ
Rearranging equations (A.6) and (A.7),
1 ⎛ λLY λLX ⎞ λ KX
Define, μ = (λLY − λLX ) = ⎜⎜ − ⎟⎟ K X = LX (A.10)
φ ⎝ λKY λKX ⎠ λKX ⎛ λLY λLX ⎞
⎜⎜ − ⎟⎟
⎝ λKY λKX ⎠
λLY ⎛ 1 − θ LX α ⎞
σY rˆY + μKˆ Y = −λLX σ X PˆX ⎜⎜ ⎟⎟ (A.11)
θ LY ⎝ θ KX ⎠
and
(φ + 1) ˆ
rˆY − KY = PˆX (1 − θ LX α ) (A.12)
φε
Using Cramer’s rule to solve for r̂Y .
⎡ λLY λLZ θ KY ⎤ ⎡ λ ⎤
⎢(σ Y θ + θ θ σ Z ) μ ⎥ ⎢ σ Y LY (φ + 1) ⎥
θ LY
D=⎢ LY TZ LY
⎥ = ⎢− − μ⎥ < 0
⎢ (φ + 1) ⎥ ⎢ φε ⎥
1 −
⎢⎣ φε ⎥⎦ ⎢⎣ ⎥⎦
1 λLX σ X α (φ + 1)
Therefore, rˆY = [ − μ ].PˆX (1 − θ LX α ) (A.13)
D φε
λ σ (φ + 1)
Now, suppose PˆX < 0 , then rˆY > 0 iff, LX X >μ
φε
Finally, using (A.5)
λLX σ X (φ + 1)
wˆ > 0 , iff, < με (A.14)
φ
22

λLX σ X (φ + 1)
or, ε >
φμ
KX
1+
λLX σ X φ + 1 λLX σ X KY λ σ K KY λLX σ X
or, ε > = = LX X =
μ φ μ KX μ KY K X λKX μ
KY
⎛λ ⎞
Using (A.8), wˆ > 0 , iff, ε > σ X K X f ⎜⎜ LX ⎟⎟
⎝ λKX ⎠
The above derivation provides the proof of condition (10). !
23

Appendix II
Figure 4
Annual Growth Rate of Informal Real Wage
50
40
30
Growth Percent
20
10
-10
-20
-30
H
R
P
P
PN
TN
TR
I
P
E
J
JK
O
J
H
N
H
KE
SI
PO
Y
A
BH
AN
A
B
AP
AS
KA
LA
M
R
G
U
M
M
M
O
H
C
D
D
N
M
W
G
States
1984-85 to 1989-90 1989-90 to 1994-95 1994-95 to 1999-00

1999-00 to 2000-01 Post Reform Average
Source: NSS Reports, various rounds and own calculations
List of abbreviations for states and union territories in India : AP – Andhra Pradesh, AS – Assam, BH – Bihar, GJ – Gujarat, HY – Haryana
HP – Himachal Pradesh, KA – Karnataka, KE – Kerala, MP – Madhya Pradesh
MH – Maharastra, OR – Orissa, PN – Punjab, RJ – Rajasthan, TN – Tamil Nadu
TR – Tripura, UP – Uttar Pradesh, WB – West Bengal, AN – Andaman and Nicobar Islands
Ch – Chandigarh, DN – Dadra and Nagar Haveli, DH – Delhi, LA – Lakshadweep
PO – Pondicherry, GO – Goa, JK – Jammu and Kashmir, MA – Manipur
ME – Meghalaya, MI – Mizoram, NA – Nagaland, SI - Sikkim.
24
Figure 5
Annual Growth Rates for Formal Real Capital Stock and Informal Real Fixed Asset
160
140
120
100
Growth Percent
80
60
40
20
-20
-40
AP AS BH GJ HY HP KA KE MP MH OR PN RJ TN TR UP WB AN CH DN DH PO GO JK MA ME NA
States
84-85 89-90(F) 89-90 94-95(F) 94-95 99-00(F)

84-85 89-90(I) 89-90 94-95(I) 94-95 99-00(I)
F – Formal Sector, I – Informal Sector.
Source: NSS Various rounds, ASI Reports, GOI and own calculations
25
Figure 6
Annual Growth rate of Informal Wage between 1984-85 and 2000-01
100.00000
80.00000
60.00000
40.00000
20.00000
0.00000
-20.00000
-40.00000
-60.00000
MP
MP
MP
HP
UP
CH
CH
CH
TN
TN
TN
OR
GO
GO
GO
GJ
GJ
GJ
AP
NA
NA
NA
IW_89-90 IW_94-95 IW_1999-2000 IW_2000-2001
Table 1. Table showing annual growth rates of real informal wage for states and union
territories in India
1984-85 to 1989-90 to 1994-95 to 1999-00 to
States 1989-90 1994-95 1999-00 2000-01 Post Reform Average
AP -14.9383 38.37914 0.351421 5.54216 14.75757
AS -12.5909 9.400387 0.502013 19.94701 9.949804
BH -12.4796 9.259229 -0.91022 37.41843 15.25582
GJ -8.01461 5.856186 3.761828 9.471879 6.363298
HY -15.417 23.39205 -4.11872 33.07289 17.44874
HP -11.5206 -0.34082 3.509483 24.55454 9.241068
KA -12.8237 21.54953 7.021524 13.43834 14.00313
KE -14.8953 12.55645 2.686628 21.20452 12.1492
MP -12.6123 22.41174 1.455013 13.11878 12.32851
MH -6.4 9.7482 5.247609 11.28708 8.760962
OR -13.1553 22.78583 -2.38878 33.1919 17.86298
PN -15.1443 12.20414 -1.06954 44.061 18.39853
RJ -15.4959 32.53101 -1.34439 33.03571 21.40744
TN -10.1074 6.406688 14.13201 11.49062 10.67644
TR -14.3066 14.89337 -5.45877 45.36927 18.26796
UP -13.2014 18.00436 -1.58454 26.79013 14.40332
WB -11.2556 11.41085 -7.25447 15.29931 6.485231
AN 14.62978 3.202789 2.910365 6.914311
CH 19.21098 5.496664 12.4677 12.39178
DN 9.828439 -4.01589 37.7676 14.52672
DH 13.26679 20.39249 12.10498 15.25476
LA -0.21334 9.929694 7.832409 5.849589
PO 20.77112 -3.96475 -18.5548 -0.58281
GO 20.50309 0.947838 23.74566 15.06553
JK 20.71262 2.838103 33.64066 19.06379
MA 24.9116 -4.18481 26.83254 15.85311
ME 18.91503 -5.28746 33.57459 15.73405
MI 19.93168 -6.92451 24.69716 12.56811
NA 15.62657 -1.96228 25.16228 12.94219
SI 28.81384 -0.01264 42.15758 23.65293
Source: NSS Reports on Unorganized Sector in India, Various Rounds, and Own Calculations
26

Table 2. Descriptive statistics for the variables (Year-Wise)
Variables Mean SD Skewness Kurtosis Minimum Maximum Observations
Year
IW (-) 15.08 3.45 0.97 3.16 (-) 18.96 (-) 6.75 17
FA 4.71 9.29 0.54 3.18 (-) 10.75 26.92 17
1989-90
VA (-) 7.90 7.12 1.20 4.20 (-) 19.04 10.00 17
RW (-) 7.56 3.48 (-) 0.13 1.94 (-) 14.38 (-) 2.80 17
IW 20.72 10.97 0.22 3.03 (-) 0.43 47.97 30
FA 3.23 12.93 1.36 5.99 (-) 19.28 47.98 30
1994-95
VA 5.89 13.31 1.98 7.94 (-) 12.24 56.44 30
RW 8.03 6.94 (-) 0.37 2.90 (-) 8.23 20.73 28
IW 1.29 7.65 1.26 4.76 (-) 9.07 25.49 30
FA 58.50 50.32 1.35 4.16 (-) 13.24 208.01 30
1999-2000
VA 42.05 32.67 1.47 4.93 3.48 140.38 30
RW 5.91 13.94 0.08 2.71 (-) 25.00 37.93 30
IW 44.18 28.51 (-) 0.52 3.30 (-) 37.11 90.74 30
FA (-) 10.52 35.77 0.87 4.19 (-) 69.15 99.74 30
2000-2001
VA (-) 40.18 25.04 0.82 4.42 (-) 94.69 26.49 30
RW (-) 2.07 17.17 2.22 7.34 (-) 19.91 58.87 29
IW 16.16 26.84 0.81 3.20 (-) 37.11 90.74 107
FA 15.10 43.33 1.69 7.54 (-) 69.15 208.01 107
All years
VA 0.92 38.68 0.59 4.54 (-) 94.69 140.38 107
RW 2.13 13.52 1.12 5.14 (-) 25.00 58.87 104
Description of the variables: IW = Annual Growth rate of real informal wage
FA = Annual Growth rate of real fixed assets
VA = Annual Growth rate of real value-added
RW = Annual Growth rate of real rural wage
Table 3. Correlation coefficient matrix (Year-Wise)

1989-90 IW FA VA RW
IW 1.00000 .42767 .57368 .27155
FA .42767 1.00000 .37750 -.09812
VA .57368 .37750 1.00000 -.03692
RW .27155 -.09812 -.03692 1.00000
1994-95 IW FA VA RW
IW 1.00000 .33932 .27046 .28607
FA .33932 1.00000 .04867 .00108
VA .27046 .04867 1.00000 .17476
RW .28607 .00108 .17476 1.00000
1999-2000 IW FA VA RW
IW 1.00000 .06356 .35441 .14441
FA .06356 1.00000 .13441 -.38761
VA .35441 .13441 1.00000 -.07614
RW .14441 -.38761 -.07614 1.00000
2000-2001 IW FA VA RW
IW 1.00000 .15125 .54512 -.15355
FA .15125 1.00000 -.20262 .16064
VA .54512 -.20262 1.00000 .02964
RW -.15355 .16064 .02964 1.00000
27

Table 4. Regression results for individual time-points corrected for heteroscadasticity
METHODOLOGY: Generalized Least Squares
Dependent variable: Annual Growth Rate of IW
Year Exp. Coeff. t-ratio R2 Adj. R2 AIC LL

Variables
(-) 11.35 (-) 6.70473*
CONSTANT
1989-90 FA 0.102 2.58869* 0.48 0.36 5.01 (-) 39.10
VA 0.233 5.09886*
RW 0.313 1.73243**
CONSTANT 15.89 8.84668*
FA 0.278 2.19006*
1994-95 0.23 0.14 7.59 (-) 109.98
VA 0.183 1.74465**
RW 0.354 1.89854**
CONSTANT (-) 3.76 (-) 1.62243
FA 0.014 0.45872
1999-2000 0.16 0.06 6.961 (-) 100.42
VA 0.083 2.04059**
RW 0.114 0.98769
CONSTANT 69.56 5.69114*
FA 0.152 0.86366
2000-2001 0.30 0.23 9.41 (-) 137.09
VA 0.607 2.23908*
RW (-) 0.307 (-) 2.30538*
Note: * denotes significance at 5% level & ** denotes significance at 10% level
Adj. R2 = adjusted R2
AIC = Akaike Information Criterion
LL = Log-likelihood
28

Table 5. Unbalanced panel regression
Random Effects Model: v(i, t) = e(i, t) + u(i)
Methodology: 2-step GLS
| Estimates: Var [e] = .251075D+03
| Var [u] = .145978D+04
| Corr [v(i, t),v(i, s)] = .853246
| Lagrange Multiplier Test vs. Model (3) = 157.18 (1 df, prob value = .000000)
| (High values of LM favor FEM/REM over CR model.)
| Fixed vs. Random Effects (Hausman) = 2.07 (3 df, prob value = .558458)
| (High (low) values of H favor FEM (REM).)
| Reestimated using GLS coefficients:
| Estimates: Var[e] = .251113D+03
| Var[u] = .304627D+04
| Sum of Squares .106765D+06
| R-squared -.398626D+00
⇒ RE model is inconsistent, which leads us to use a Fixed Effects Model. The results from the LSDV
(group Dummy) model is given below.
Least Squares with Group Dummy Variables

| Ordinary least squares regression Weighting variable = none
| Dependent variable = REALIW Mean= 16.16169250, S.D.= 26.83556242
| Model size: Observations = 107, Parameters = 7, Deg. Fr.= 100
| Residuals: Sum of squares= 25107.46507, Std. Dev = 15.84534
| Fit: R-squared= .671091, Adjusted R-squared = .65136
| Model test: F [6, 100] = 34.01, Probability value = .00000
| Diagnostic: Log-L = -443.8343, Restricted (b=0) Log-L = -503.3250
| Log Amemiya Probability Criterion. = 5.589, Akaike Info. Criterion = 8.427
| Estd. Autocorrelation of e (i, t) .139228
White/Heteroscedasticity corrected covariance matrix used.
Results from Heteroscedasticty-corrected Panel (Fixed Effects) Regression
Explanatory Variable Coefficient Standard Error t-ratio

REALFA 0.030422 0.049421 0.616
REALVA 0.256675** 0.070371 3.647
REALRW -0.04538 0.160961 -0.282
** Significant at 1% level
29

Table 6. Identifying structural breaks
Exp.
Years Variables Coeff. t-ratio
1989-90 & 1994-95 FA (-) 0.03 (-) 0.13698
Checking for structural breaks at 1994-95 VA 0.546 1.85573
RW 1.22 2.92752
T2 = INTERCEPT DUMMY T2 16.00 4.26033*
FA2 = T2 INTERACTS WITH FA FA2 0.396 1.05172
VA2 = T2 INTERACTS WITH VA VA2 0.064 0.154686
RW2 = T2 INTERACTS WITH RW RW2 (-) 1.04 (-) 1.8349
1994-95 & 1999-2000 FA 0.397 2.41241

RW 1.41 6.34088
T3 = INTERCEPT DUMMY T3 (-) 3.76 (-) 0.81685
FA3 = T3 INTERACTS WITH FA FA3 (-) 0.383 (-) 2.23524*
VA3 = T3INTERACTS WITH VA VA3 (-) 0.226 (-) 1.29278
RW3 = T3 INTERACTS WITH RW RW3 (-) 1.29 (-) 4.64913*
1999-2000 & 2000-2001 FA (-) 0.008 (-) 0.14337

RW 0.052 0.220547
T4 = INTERCEPT DUMMY T4 69.56 10.3654*
FA4 = T4 INTERACTS WITH FA FA4 0.160 1.4042
VA4 = T4INTERACTS WITH VA VA4 0.553 3.37302*
RW4 = T4 INTERACTS WITH RW RW4 (-) 0.359 (-) 1.15813
Dependent variable = Annual Growth Rate of IW
Table 7. Regressing current period’s BPL percentage on previous year’s annual

growth of informal wage
Dependent variable: BPLPER
Methodology: OLS
Exp. Variables Coeff. t-ratio R2 AIC Log - Likelihood
IWPREV (-) 0.236 (-) 2.57* 0.13 7.883 (-) 183.2454
CONSTANT 27.85 14.53*
Note: BPLPER = BPL percentage
IWPREV = Previous year’s growth rate of informal wage
30

Table 8. Unbalanced panel regression of current period’s BPL percentage on previous
year’s annual growth of informal wage
Dependent variable: BPLPER
Model: Random Effects Model
Exp. Variables Coeff. t-ratio
IWPREV (-) 0.229 (-) 5.17*
CONSTANT 27.12 11.98*
Diagnostics tests for the model:
Random Effects Model: v(i,t) = e(i,t) + u(i)

Estimates: Var[e] = .253153D+02
Var[u] = .129246D+03
Corr[v(i,t),v(i,s)] = .836212
Fixed vs. Random Effects (Hausman) = .01

(1 df, prob value = .940154)
(High (low) values of H favor FEM (REM).)
Reestimated using GLS coefficients:
Estimates: Var[e] = .253158D+02
Var[u] = .129353D+03
Sum of Squares .672385D+04
R-squared .124856D+00
Note: BPLPER = BPL percentage
IWPREV = Previous year’s growth rate of informal wage
Figure 7a Figure 7b
Durgapur--- Manufacturing
Durgapur---- Manufacturing
Persons better-off (on the basis of
Persons better-off (on the basis of
annual household incom e) in 1991-2005
annual household income) in 2000-05 in
in com parison to before 1991
comparison to 1991-2000
Better Off 42%

47% Better Off
53% Worse off Worse off
58%
31

Figure 7c Figure 7d
Durgapur--- Services
Durgapur--- Services Persons better-off (on basis of
Persons better-off (on basis of annual annual household incom e) in 2000-05
household incom e) in 1991-2005 in in com parison to 1991-2005
com parison to before 1991
11%
20%
better-off
better-off
w orse-off
w orse-off
80%
89%
Table 11. Results of primary survey in Kolkata (Manufacturing Units)
Kolkata
Panel A Descriptive Statistics

Standard No of
Mean Deviation Skewness Kurtosis Minimum Max. Cases
Y 37646.3 23061.1 0.967373 4.13229 3000 112000 57
C 8360.7 9685.38 1.23772 3.42979 240 35000 57
P 106.368 150.419 2.16753 9.08813 0.5 801 57
Panel B Regression Results

METHODOLOGY: Ordinary Least Squares
Dependent Variable: Annual Informal Household Income
Coefficient Standard Error t-ratio P-value
Constant 27942.6 4036.74 6.92206 4.66E-09
C 0.77643 0.336021 2.31066 0.024559
P 2.66432 12.9908 0.205093 0.838243
# C – Fixed Capital Stock; P – Price per unit; Y – Annual Household Income
32

Table 12. Results of primary survey in Howrah (Manufacturing Units)
Howrah

Standard No of
Y 48421.1 13728.2 0.637803 2.5228 30000 80000 60
C 47342.9 22493.1 0.478837 2.87829 7000 100000 60
P 1022.15 2101.96 5.03217 33.2572 6 15000 60

Constant 39146.4 2896.04 13.5172 0
C 0.250499 0.070518 3.55227 0.000775
P -0.00985 0.989081 -0.00996 0.992087
Table 13. Results of primary survey in Durgapur (Manufacturing Units)
Durgapur

Standard No of
Y 39247.8 27293.2 0.707129 2.91077 1350 110000 48
C 150491 307651 2.2216 6.11462 700 1.00E+06 48
P 965.34 1837.46 2.19362 7.171 1.5 7935 48

Constant 32000.1 4889.38 6.54483 3.95E-08
C 0.012638 0.016261 0.777216 0.440926
P 2.26698 2.25657 1.00462 0.320226
# C – Fixed Capital Stock; P – Price per unit
33

Table 14. Results of primary survey in Siliguri (Manufacturing Units)
Siliguri

Standard No of
Y 37978 23854.8 2.18232 8.73795 3600 144000 100
C 23708.8 68809.5 5.53408 35.901 100 500000 100
P 610.042 1795.99 5.9622 45.7833 0.35 15250 100

Constant 34360 2183.5 15.7362 0
C 0.191685 0.049122 3.90224 0.000176
P 0.965398 1.58032 0.610887 0.542703
34

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MPIA Working Paper

The Urban Informal Sector and Poverty :

Sugata Marjit (Centre for Studies in Social Sciences,

Keywords: Informal Wage, Capital Mobility, Trade Reform, Poverty, India

JEL Classifications: F13, F16, O17, J21, J31

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2. Literature Review and Specific Objectives

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Furthermore, unlike previous studies, here we bring in imperfections in the allocation

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The symbols we use are given as follows:

w: Formal unionized wage; w: Informal (flexible) wage

ri : Return to capital in sector i; X: Output of formal sector;

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L: Supply of Labor; K: Total supply of capital

w aLX + rX aKX = PX (1 + t ) (1)

waLY + rY aKY = PY (2)

Full employment conditions imply:

aLX X + aLY Y = L (3)

Let ŵ be so determined that,

wˆ = αPˆX + βPˆY , 0 < α , β < 1 (7)

Finally, the capital mobility condition:

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Given ( PX + t , PY ) , w , L, and K, we have w, rX , rY , X, Y, K X , KY to solve from (1)-

Given rY a drop in rX increases KY , as φ > 0 . This will mean a rightward shift of MM to

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labor at a given rY , hence at a given w to induce an increase in w. With zero mobility MM is

shift in FF. With perfect mobility MM is horizontal at rY = rX and as rX drops, MM shifts

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Following the plan of empirical study, we begin by providing observations on the

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Based on these observations, we offer results from a generalized least square

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5. Impact on Impact on Poverty and Further Evidence from Primary Survey

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The secondary evidence was corroborated by a primary survey spanning the

The sample is quite heterogeneous by informal occupational types of the

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waLY + rY aKY = PY (A.2)

From (A.1), rˆX θ KX = PˆX − θ LX w

ˆ = αPˆ + βPˆ = αP̂ , since Pˆ = 0 .

Again, λLX Xˆ + λLY Yˆ + λLX aˆ LX + λLY aˆ LY = 0

Rearranging, and using (A.4), and θ LY ( wˆ − rˆ) = −rˆY

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1984-85 to 1989-90 1989-90 to 1994-95 1994-95 to 1999-00

84-85 89-90(F) 89-90 94-95(F) 94-95 99-00(F)

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Table 3. Correlation coefficient matrix (Year-Wise)

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Year Exp. Coeff. t-ratio R2 Adj. R2 AIC LL