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This paper proposes a model that allows testing for labor market segmentation between the formal and informal sectors in a developing country on the basis of cross-sectional data. Tests of labor market segmentation are usually based on a comparison of observed wages in two sectors. Wage differences for identical workers in different sectors can be attributed to differences in preferences attached to participation in a sector and to restrictions in mobility between sectors. While the latter can be regarded as an indicator of " true " labor market segmentation, compensating wage differentials resulting from preferences also exist, even in the absence of rationing. So far, the applied tests have been unable to distinguish between these two effects. The proposed model overcomes this weakness by incorporating search information on how individuals (both employed and unemployed) search for new jobs and information about "" discouraged "" workers who have stopped searching for jobs. The proposed model accounts for all of the specific features of urban labor markets in developing countries, in particular the existence of a competitive informal sector. The model is estimated using data from the 1989 Bolivian Integrated Household Survey by means of a smooth simulated maximum likelihood estimator. The estimates show that the degree of labor market segmentation differs strongly between educational groups.

Publisher: World Bank

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