Informal employment in India: Voluntary choice or a result of labor market segmentation?

As of 2011-12, informal workers in India comprise 85.8 percent of the total labor force. This paper uses India's National Sample Survey data on Employment and Unemployment (2011-12) to test whether the large share of informal employment is due to labor market segmentation or a result of competitive choice. Results show that workers can freely enter informal employment. In contrast, there is no evidence of self-selection into formal employment. Based on this evidence, we cannot reject the labor market segmentation hypothesis for the Indian labor market. The wage gap decomposition results show that informal workers earn less than formal workers not only because they are less skilled, but also because they receive lower returns to their endowments compared to the formal workers. Thus, policies that focus on skill development may be necessary but are not sufficient to increase formal job opportunities and reduce the formal-informal wage gap. © 2016 Indian Society of Labour Economics.