1

Informal Labor Market Participation in Tajikistan.

(Project Proposal for EERC Competition, Spring 2012)

Ulugbek Rahimov1 Davron Ruzmetov2

April 12, 2012

Abstract: Individuals can choose to be employed in the informal sector as a

result of competitive market forces or labor market segmentation. However, the

informal sector has a heterogenous structure and the existing literature fails to

sufficiently explain informal employment. Precisely, some individuals enter the

informal sector if there an attractive employment opportunity while others view it

as a strategy of last resort. We test this hypothesis using finite mixture regression

with sample selection using data from Tajikistan.

.

Keywords: informal employment, informal sector, labor market

participation, poverty

JEL Codes: J71, J64, O12, P23

1 Corresponding author. Westminster International University in Tashkent, 12 Istiqbol St., Tashkent

100047, Uzbekistan. Email: rkulugbek@gmail.com 2 The Association of Business Incubators and Techno Parks of Uzbekistan.

2

1. Introduction

Labor markets in developing countries usually consist of small, well-

organized formal sector with relatively high earnings, and a large informal sector

with low and volatile earnings. The extant literature3 accommodates two

opposing theories of informal employment. The segmentation hypothesis

assumes that individuals escape involuntary unemployment and opt for informal

arrangements, whereas according to the comparative advantage hypothesis,

informal employment is the result of voluntary income or utility maximization. An

important question for policy recommendations, is whether the observed

differences in earnings in the formal and informal sectors are the result of market

segmentation or whether competitive labor market theories hold despite the

observed wage differences. In other words, the question is whether individuals

choose to participate in the informal sector voluntarily or if they are forced into

informal employment because of exclusion from the formal sector.

An implication of the segmentation hypothesis is that individuals are poor as

a result of informal employment (e.g., Harris and Todaro, 1970). Alternatively, the

comparative advantage hypothesis suggests that individuals can only obtain

informal employment because they are poorly endowed with characteristics

necessary for high return employment in the formal sector (e.g., Maloney, 2004).

So far, vast empirical literature has assumed that the informal sector is

homogenous. For example, Magnac (1991) tests for competitiveness in the

developing countries. In a complementary paper, Gindling (1991) uses a

3 Some of the recent theoretical research on the causes and consequences of informality include Maloney

(2004), Fields (2005), Loayza and Rigolini (2006), Amaral and Quintin (2006), Bennett and Estrin (2007) and Bennett (2008). A review of the relevant issues is offered in World Bank (2007) and Battini et al. (2010).

3

generalized regression with sample selection. Pratap and Quintin (2006) take a

semi-parametric approach to test for labor market segmentation hypothesis. The

results of all three papers support the competitive labor market hypothesis where

the informal sector employment is a choice rather than a strategy of last resort.

However, the homogeneity assumption has recently been called into

question. For example, Fields (2005) distinguishes between the so-called “upper”

and “lower” tiers of the informal sector. The upper tier includes competitive

people who expect to earn more in the informal than in the formal sector and

choose to enter informal employment. The lower tier consists of the people

excluded from the formal sector and remain in the informal sector out of

necessity. Paulson and Townsend (2005) consider different macroeconomic

dynamics: some escape unemployment by launching informal enterprises during

economic crises while others enter the informal sector during normal times. They

show that the former earn a much lower profit than the latter, particularly because

the latter have much higher start-up investments.

However, empirical literature on heterogeneous informal labor markets is

very thin. The biggest obstacle is data availability as, typically, only data on

informal affiliation is available while data on the underlying individual motivations

is not. Therefore, whether informal employees view the informal sector as an

opportunity or necessity is not directly observable. To our knowledge, there exist

only two papers that allows for unobserved heterogeneity in the informal sector.

Cunningham and Maloney (2001) view the informal sector as a two-tier mix of

informal entrepreneurs4. Günther and Launov (2012) develop an econometric

model which is able to detect unobserved heterogeneity in the informal sector

4 They do not consider wider options of salaried employment or staying out of the labor market.

4

while covering all employment options in the labor market. One of the main

advantages of their model is that it can be applied to a general household survey

and not necessarily to a labor market survey. This is important as even panel

data on labor markets does usually not provide enough information to test for

involuntary vs. voluntary informal employment.

This research project employs the approach of Günther and Launov (2012),

termed as a finite mixture regression with sample selection by the authors

themselves, to test for a dual structure of the informal sector in Tajikistan, with

both voluntary and involuntary employment. The results of this research will have

important policy implications. In particular, for policies aiming to combat informal

employment for employee protection or tax collection purposes. Such policies

have to address both individuals who would like to switch to a formal job and

individuals who currently have no incentive for doing so. From a poverty

perspective, it implies that informal employment can be both a cause and a result

of poverty.

The next Section explains the theoretical model and estimation strategy of

Günther and Launov (2012). In Section 3 we discuss the available data that we

plan to use for this study. Section 4 covers policy implications followed by

organizational details in Section 5.

2. The Model

The setup of the model is as follows. The labor market Y consists of J

segments Yj with free entry, where the log-earnings of an individual i in segment j

are described by the following wage equation:

jijjiij iuy ,'ln (1)

5

Before proceeding any further it is important to make some parametric

assumptions. Namely that the error terms are uncorrelated across segments and

follow a normal distribution with zero mean and variance σj2. Also, that the wage

function, i.e. the returns (βj) to individual characteristics (Xi), varies from segment

to segment. In line with the literature, we also assume that occupational choices

can be explained by a set of personal characteristics with the following

specification:

)1,0(~,' NuuZy isisjiis (2)

To test whether the distribution of individuals across the sectors of the labor

market is driven by market segmentation or a result of comparative advantage,

we assume that every worker solves earning maximization problem given the

wage function. In other words, any individual must be found in the sector where

his expected earnings, conditional on his personal characteristics, are the

highest. Thus, the distribution function conditional on both individuals'

characteristics and the returns to these characteristics in each labor market

segment is given by:

iisil

Jlliisijj XyyEXyyEPYiP ;0lnmax;0ln

],1[,

(3)

Note, however, that this is the hypothetical distribution function. In reality,

household surveys do not provide information on the motivation behind

occupational choices. Treating the sector affiliation as unobserved yields the real

distribution function:

J

jjisiji yyfyf

1

,0 (4)

6

where jsyyf ,0 defines the distribution of unobserved wages in a given labor

market sector5. If one fails to reject a hypothesis that the hypothetical and real

distributions of workers are equal, it implies that individuals are found in sectors

with the highest payoff conditional on personal characteristics. Rejection, on the

contrary, implies administrative barriers to mobility which supports the market

segmentation hypothesis.

Since we know whether an individual belongs to the formal or informal

sector6, for the estimation strategy we rely on Günther and Launov (2012) who

propose to proceed with the following steps:

1. Use probit to estimate γ from the model given by equation (2);

2. Use ̂'iZ as consistent estimates of 'iZ to estimate (4).

3. Data

For the empirical analysis of the model we shall use the datasets of the

Tajikistan Living Standards Survey from 1999, 2003 and 2007 which are cross-

sections7. The sample of about 1500 households is representative at the

national, regional level (4 regions and Dushanbe), and urban/rural subgroups.

The descriptive statistics of the dataset for variables that are required to perform

the estimations is provided in Table 1. The sample only includes people of age

14 and higher as the Tajikistan LSMS restricts labor market questions to such

individuals.

5 In Günther and Launov (2012) this f(.) is given by equation (3).

6 What we do not know is which part of the informal sector the individual is involved in.

7 There is also the 2009 survey, which is a panel survey of 1,500 households interviewed during the 2007

wave. However, at the present we are not sure whether the panel aspect of the data can be of any use. Therefore we resort to the earlier cross-sections. All the datasets and survey documentation is provided in open access by The World Bank.

7

Table 1. Descriptive Statistics8

Total Inactive

Active

Informal Formal Observations (sample size) 16978 9196 3561 4221

Sample (%) Monthly earnings 217,4 - 220,3 214,9

Variables in wage equation

Sex (male = 1, %) 46,8 34,3 64,8 58,9 Age (years) 33,3 30,6 34,9 37,7 Education (years) 10,4 9,9 10,6 11,5 Education (%) None 0,5 0,6 0,4 0,2 Low 25,0 32,4 20,2 13,7 Medium 62,4 59,8 71,1 60,9 High 10,3 4,7 7,3 25,1 Literacy (yes = 1, %) 98,6 98,1 99,1 99,4 Living in Dushanbe (yes=1, %)

15,5 16,5 12,6 15,8

Exclusion variables in selection equation Infants in HH 0,5 0,5 0,5 0,5 Children in HH 1,9 1,8 2,1 2,0 HH Size 7,3 7,3 7,4 7,2 Active HH members 2,1 1,6 2,7 2,7

In contrast to Günther and Launov (2012) we do not use data on religion. The

reason is that the Tajikistan LSMS does not collect such data. A natural proxy for

religion in Central Asia could be the ethnicity. For example, two biggest religions

in the region are Islam and Christianity with the vast majority of the local

ethnicities practicing the former and the Russians, along with other Slavic groups,

practicing the latter. However, in the 2007 wave only 175 out of 29173

respondents identifying their ethnicity are Russians while the rest consists of the

local ethnicities such as Tajiks, Uzbeks, etc. Therefore, we discard religion.

4. [Expected] Results and Policy Implications

The evidence on whether informality is good or bad in the literature is mixed.

On the one hand, among others, informality leads to poor working conditions,

social vulnerabilities, inefficient public institutions and low fiscal revenues. On the

8 For 2007 only. The final results will be based on datasets of all available waves.

8

other, labor market informality can increase efficiencies where the formal

economy is unable to do so due to administrative barriers and segmentation.

Therefore, for a number of dimensions of policy making it is very important

distinguish individuals who would like to switch to a formal job and individuals

who currently have no incentive for doing so.

This study based on the Günther and Launov (2012) framework which

provides the following advantage. First, it generates consistent estimates of

returns to individual characteristics within any of the segments of the informal

sector9. Second, it provides an intuitive approach to identify the size of voluntary

and/or involuntary employment in the informal sector10. From an econometric

perspective, their finite mixture regression with sample selection shows that

ignoring the employment decisions of individuals can lead to misspecified tests

for labor market segmentation in developing economies (Dickens and Lang,

1985; Cunningham and Maloney, 2001) or a possible latent heterogeneous

structure of the labor market (Heckman and Sedlacek, 1985; Magnac, 1991;

Pratap and Quintin, 2006).

5. Project Implementation

The proposed research project shall be implemented by a team of 2

researchers, both based in Uzbekistan:

Ulugbek Rahimov, the team leader, is presently pursuing his research

degree (Kandidat Nauk) at the Tashkent State Economics University. He

has extensive academic experience both in teaching and research. He

9 See Heckman (1979), Dickens and Lang (1985) and Magnac (1991).

10 See Maloney (2004) and Fields (2005).

9

holds Master’s degree from the University of Birmingham and is presently

a lecturer at the Westminster International University in Tashkent.

Davron Ruzmetov has some research experience including one paper in

progress while having done a large body of policy analysis for the

Association of business incubators in Uzbekistan, where he currently

serves as the Vice President. He intends to study for a PhD in Western

Europe or North America.

While both members of the research team will contribute equally to empirical

analysis, Ulugbek Rahimov will be leading the team and bearing the

responsibility for final versions of all reports to the EERC. The timing of

deliverables is given in Table 2.

Table 2. Timing of Deliverables

Time period Tasks to complete

01/08/2012 – 31/09/2012 Comprehensive literature review and motivation of the research question and the resulting paper.

01/10/2012 – 15/11/2012 Preliminary data analysis and specified tests.

16/11/2012 – 15/12/2012 The first report to EERC on the preliminary results.

16/12/2012 – 31/01/2013 Revision of the first draft as well as the empirical strategy based on the comments during the EERC workshop.

01/02/2013 – 31/03/2013 Revised report (possibly with updated results)

01/04/2013 – 30/06/2013 Presentation of the results in research seminars and start of the writing of the academic paper based on the results of the study.

01/07/2013 – 31/07/2013 Incorporated comments, received during the EERC workshop both from the audience as well as the experts.

01/08/2013 – 30/08/2013 Finalization of the academic paper and submission to a peer-reviewed journal.

10

Bibliography

Amaral, P. and Quintin, E. (2006) “A competitive model of the informal sector”, Journal of Monetary Economics, 53(7), pp. 1541–1553.

Batini, N., Kim, Y.-B., Levine, P. and Lotti, E. (2010) “Informal Labour and Credit Markets: A Survey”, IMF Working Paper 10/42.

Bennett, J. (2008) “Formality, informality, and social welfare”, IZA Discussion Paper No.3550.

Bennett, J. and Estrin, S. (2007) “Informality as a stepping stone: entrepreneurial entry in a developing economy”, IZA Discussion Paper No.2950.

Cunningham, W. and Maloney, W. (2001) “Heterogeneity in the Mexican micro-enterprise sector: an application of factor and cluster analysis”, Economic Development and Cultural Change, 50(1), pp. 131–156.

Dickens, W. and Lang, K. (1985) “A test of dual labor market theory”, The American Economic Review, 67(2), pp. 792–805.

Fields, G. (2005) “A guide to multisector labor market models”, Paper prepared for the World Bank Labor Market Conference, URL: http://www.ilr.cornell.edu/directory/gsf2/downloads/Multisector_mar05.pdf.

Gindling, T. (1991) “Labor market segmentation and the determination of wages in the public, private-formal and informal sectors in San-Jose, Costa-Rica”, Economic Development and Cultural Change, 39(3), pp. 585–603.

Günther, I. and Launov, A. (2012) “Informal employment in developing countries: Opportunity or last resort?”, Journal of Development Economics, 97(1), pp. 88-98.

Harris, J. and Todaro, M. (1970) ”Todaro, Migration, unemployment and development: a two-sector analysis”, The American Economic Review, 60(1), pp. 126–142.

Heckman, J. and Sedlacek, G. (1985) “Heterogeneity, aggregation and market wage functions: an empirical model of self-selection in the labor market”, Journal of Political Economy, 93(6), pp. 1077–1125.

Loayza, N. and Rigolini, J. (2006) “Informality trends and cycles”, The World Bank Policy Research Working Paper No.4078.

Magnac, T. (1991) “Segmented or competitive labor markets”, Econometrica, 59(1), pp. 165–187.

Maloney, W. (1999) “Does informality imply segmentation in urban labor markets? Evidence from sectoral transitions in Mexico”, The World Bank Economic Review, 13(2), pp. 275–302.

Maloney, W. (2004) “Informality revisited”, World Development, 32(7), pp. 1159–1178.

11

Paulson, A. and Townsend, R. (2005) “Financial constraints and entrepreneurship: evidence from the Thai financial crisis”, Economic Perspectives, 3Q, pp. 34–48.

Pratap, S. and Quintin, E. (2006) “Are labor markets segmented in developing countries? A semiparametric approach”, European Economic Review, 50(7), pp. 1817–1841.

The World Bank (2007) “World Bank, Informality: Exit and Exclusion”, The World Bank, Washington D.C (2007).

1

Mr. ULUGBEK RAHIMOV

Lecturer, Economics

Westminster International University in Tashkent

12 Istiqbol St., Tashkent 100047, Uzbekistan

rkulugbek@gmail.com

PERSONAL INFORMATION

Date of birth: 30 August 1979

Nationality: Uzbekistan

Marital status: Married, 2 children

EDUCATION

2009 - present PhD Program (Kandidat Nauk)

Thesis title: “Empirical Studies of Finance and Entrepreneurship in

Central Asia”

Tashkent State Economics University, Uzbekistan

2000 - 2002 Master of Science in Public Economic Management and Finance

International Development Department, School of Public Policy

University of Birmingham, United Kingdom

1996 - 2000 Bachelor's Degree in International currency-credit relations

Faculty of Finance and Credit

Tashkent Financial Institute, Uzbekistan

RESEARCH

“Entrepreneurial entry and exit in Tajikistan” (in progress)

“Specifics of mortgage financing in Uzbekistan” (in progress)

EMPLOYMENT

Feb 2011- present National consultant, UNDP Uzbekistan. The research project funded by UNDP; the aim of the project is to analyse the need

for microfinance, and further development strategy. I am responsible for the project

report on the assessment of demand for microfinance.

March – June, 2009 Research Analyst, Japanese International Cooperation Agency. Research project to study various risks and issues for future investments interests of

Japanese Bank for International Cooperation. I was responsible for International

Trade section (which includes export and import, exchange rate regulation, and

repayment capability in Uzbekistan) and Banking section (regulation of Banking

system).

Aug 2008 – present Lecturer, Westminster International University in Tashkent (WIUT) Teach the following courses at WIUT:

“Macroeconomic Analysis and Policy” (third year)

“Development economics” (third year)

“Advanced Economics” (fourth year)

Assistant/tutor for:

“Mathematics for Economics” (firth year)

“Economics Project” (supervision of final year project of undergraduate

students)

2

Aug 2006 –

May 2008

Financial supervisor, CTSD Limited Japanese Company, Russian

Federation. Supervised finance team with 3 assistant accountants; distributed financial resources

among bank accounts; allocated resources for payments and deposits; monitored

cash flows of London accounts in all currencies; prepared monthly reports for VAT

calculation, project costs, bank transactions and ensure their timely submission to

the head office; organized team work for purchase book preparation; prepared all

financial and administrative documents related to the finance in accordance with

Russian accounting legislation; maintained payment files and kept information and

reference material; translated during meetings with subcontractors.

October, 2004 –

July, 2006

Research Analyst, Banking and Finance Academy, Faculty of

Banking. Delivered lecturers on “Development of banking sector in Uzbekistan”, and

“Currency circulation and credit” modules for Master program; supervising

dissertation works of master students; organizing and participating regularly in

conferences; translating lecture notes of guest lecturers.

September, 2002 –

October, 2004

Lead economist, Head of Treasury Department (after promotion), State

Commercial “Pakhta” Bank Khorazm branch, Urgench. Supervised collection of monthly financial reports on credits and loans from 12

regional braches of the bank, analyzed them and generated final financial report for

the head branch, produced short-term forecast; -developed and maintained the interest

rate risk management policy; -assisted in developing Bank’s Policy on liquidity risk.

VISITING POSITIONS

June - July, 2006 Potsdam University, Germany

CONFERENCES

11-12 May, 2006 International conference on “Mortgage financing: international

experience, problems and development prospects”

Banking and Finance Academy, Uzbekistan.

14 June, 2005 International conference “Problems of reforming banking and finance

system in Uzbekistan” Banking and Finance Academy, Uzbekistan.

PROFESSIONAL TRAINING

14-18 November 2005 Training Course for Trainers of Central Asia “International marketing

and business planning”, ICE-Rome.

3-7 April, 2006 Training Course for Trainers of Central Asia “Innovation and

technology transfer”, ICE-Rome.

24-28 April, 2006 Training Course for Trainers of Central Asia “EU: the project cycle

management” and “Strategic cooperation among SMEs: the Italian

model of export consortium”, ICE-Rome.

1-29 August, 2003 “Financial Management” Course, Uzbek-American Academy

OTHER Computer literacy: Microsoft Office MS Word, Excel, PowerPoint; Interested in Web

Designing and building PC systems.

Languages: Uzbek – native, Russian and English – excellent.

REFERENCES

Available on request.

Davron RUZMETOV

Vice President

THE ASSOCIATION OF BUSINESS INCUBATORS AND TECHNO PARKS

8, Xonzodabegim St., 700003 Tashkent, Uzbekistan

Tel.: +998.71.256.24.03 Email: davronruzmetov@gmail.com

OBJECTIVES Doctorate Degree (PhD or DBA)

RESEARCH INTERESTS

Entrepreneurship, Microfinance, Corporate Social Responsibility, Development Institutions

EDUCATION Master’s Degree in Economics, Tashkent State Economics University (July 2006)

Bachelor’s Degree in Economics, Urgench State University (July 2001)

PAPERS

“Can culture explain the expansion of microfinance industry? A cross-country analysis” jointly

with Guldurdi Pitpildikov.

“Readability of Academic Publications in Social Sciences: Evidence from JCR Panels”

(preliminary version available upon request, jointly with A.Rachi and N.Yusupov)

WORK EXPERIENCE Deputy Chairman (Sept. 2004 – Present)

The Association of Business Incubators and Techno Parks (Tashkent,

Uzbekistan)

Coordinate preparation of Business Incubators’ short term work plans.

Monitor and provide oversight over the successful development of business incubators.

Administer regular workshops and plenary meetings of regional business incubator managers.

Assist international exchanges and study visits for managers and national experts of the business

incubator’s network.

Bear responsibility for international and public relations

Lead Economist, Dept. of Support for Entrepreneurship (June 2003 – Sept. 2004)

State Committee for State Property Management and Support for

Entrepreneurship (Tashkent, Uzbekistan)

Coordinated and supervised of the SME support program’s implementation by regional offices.

Negotiated cooperative projects with the local private sector entrepreneurs, international

organisations, resident missions of international organizations.

Davron RUZMETOV

Participated in the preparation of regular (weekly, monthly, quarterly and annual) progress

reports to the government.

Represented the State Committee in inter-ministerial meetings on entrepreneurship and private

sector development.

Economist, Dept. of Monitoring, Khorezm Regional Branch (Jan. 2002 – June 2003)

State Committee for State Property Management and Support for

Entrepreneurship (Urgench, Uzbekistan)

Local monitoring over the SME support program’s implementation.

Handling of various tasks assigned by the manager.

HONORS & AWARDS Beruni Scholarship of The Government of Uzbekistan, 2000-2001

Honor Roll, Urgench State University, 1998-2001

CONFERENCES The 3rd International Conference on Humanities and Social Sciences, Faculty of Liberal Arts,

Prince of Songkla University, Hat Yai Campus, Thailand, 2011

Korean Chamber of Commerce, Seoul, 2010

“Small and private business development”, Tashkent, Uzbekistan, 2008

LANGUAGES English, Uzbek and Russian (fluent), Turkish (good), Korean (basic)