Race among equals? An inquiry into the segmentation of Indian labor market

• Published date: 01 November 2021
• Author: Rayees Ahmad Sheikh,Sarthak Gaurav,Trupti Mishra
• Date: 01 November 2021
• DOI: http://doi.org/10.1111/rode.12804

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wileyonlinelibrary.com/journal/rode Rev Dev Econ. 2021;25:2180–2206.

© 2021 John Wiley & Sons Ltd

Received: 8 January 2020

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Revised: 30 August 2020

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Accepted: 24 May 2021

DOI: 10.1111/rode.12804

REGULAR ARTICLE

Race among equals? An inquiry into the

segmentation of Indian labor market

Rayees AhmadSheikh

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SarthakGaurav

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TruptiMishra

Shailesh J. Mehta School of Management,

Indian Institute of Technology Bombay,

Mumbai, India

Correspondence

Rayees Ahmad Sheikh, Shailesh J. Mehta

School of Management, Indian Institute of

Technology Bombay, Mumbai, India.

Email: rayees018@gmail.com

Abstract

Whether identical workers are treated homogeneously in dif-

ferent sectors indicates how segmented labor markets are. In

this study, we test for segmentation in the Indian labor mar-

ket by using unit- level data from two rounds of nationally

representative data each round comprising of nearly half a

million individuals for the period 2004– 2005 and 2011–

2012. We use the finite mixture model (FMM) estimation

and correct for selection bias to find the existence of two

segments of considerable size in informal sector. We iden-

tify statistically different latent segments without a priori

definition of the segments. Workers in the upper segment

of informal employment receive higher returns to education

and skills relative to those in the lower segment. Women

earn less than men in both segments of informal and formal

employment. The gender– wage disparity, however, is less

pronounced in the lower segment of informal employment.

Furthermore, we estimate the size of involuntary informal

employment to be more than 40% of the entire informal em-

ployment. Our findings on unobserved heterogeneity sug-

gest the need to rethink about binaries in the labor market

as ideas of formal and informal employment lose relevance

when multiple latent segments coexist. The study has poten-

tial implications for design of labor policies, skilli develop-

ment programs, and labor legislation.

KEYWORDS

finite mixture models, segmentation

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INTRODUCTION

Labor markets in developing countries are characterized by the persistence of a large share of work-

force in the informal sector despite economic growth. The coexistence of a large rural agrarian and

rural nonfarm labor market along with an urban nonfarm labor market indicates a dichotomy in labor

markets in line with the “dual labor market” theory (Harris & Todaro,1970; Lewis,1954). However,

there have been recent examinations of the formal– informal dynamics of labor markets from a “seg-

mented labor market” (SLM) theory perspective (García, 2017). In this context, there is an ongoing

debate in the literature on theoretical and methodological foundations of labor market segmentation

(Leontaridi,1998).

The literature on segmentation can be traced back to seminal contributions in the 1960s (Harris &

Todaro,1970; Lewis,1954; Piore, 1983). Although these studies have identified sectors in the labor

market with different names, but the underlying proposition that there are different segments in the

labor market with different wage- setting mechanisms remains the same. The recent addition to this

literature focuses on segmentation along formal– informal lines (Dickens & Lang,1985; Fields,1990,

2005; Gindling,1991; Günther & Launov, 2012; Radchenko, 2017). The analysis of segmentation

along formal– informal lines is complicated because informality has two broad definitions: one based

on industry characteristics and the other based on worker characteristics (Hussmanns, 2004; Sheikh

& Gaurav,2020)1. Therefore, studying segmentation within informal economy, in particular, war-

rants attention. Furthermore, such an examination can be approached from two different perspectives:

industrial duality and occupational segmentation (Leontaridi,1998). The industrial def inition of in-

formality is based on firm characteristics, whereas occupational definition is based on employment

characteristics; therefore, the former highlights the segmentation at the firm level and the latter at the

employment level.

Whereas some studies find evidence for segmented labor markets (Pratap & Quintin,2006), oth-

ers find evidence in favor of competitive market theory (Magnac,1991; Maloney,1999). Also, there

is mixed empirical evidence in the literature (Günther & Launov,2012). A majority of these studies

assume that the large informal sector is homogeneous. However, following Fields' (1990) semi-

nal work, several studies presenting evidence of unobserved heterogeneity emerged. These stud-

ies demonstrated that duality exists within the informal sector as well (Günther & Launov,2012;

Radchenko, 2017).

In this study, we use the occupational perspective of informality, that is, informal employment to

test the segmentation hypothesis in India. We use the finite mixture model (FMM) (McLachlan &

Peel, 2004) corrected for selection bias to control for unobserved heterogeneity in informal employ-

ment. The FMM helps address heterogeneity by identifying the latent segments in the labor market.

Using “unit- level” data from two rounds of a nationally representative survey on employment and

unemployment, our results suggest that the informal labor market in India; considered in the form

of informal employment, has two segments.2 These segments are characterized by different wage

equations, and there are entry barriers to formal employment. Furthermore, we examine whether

informal work is voluntary in nature or a strategy of last resort by the worker vis- à- vis labor mar-

ket competition in explaining informality. Within the informal employment segments, our findings

JEL CLASSIFICATION

J01; J08; J4; J46