Evasive Reform: Informalisation in a Liberalised Economy with Wage-Setting Unions

We examine the impact of economic deregulation on employer evasion of union-mandated ‘formal’ wage-contracts in an import-competing industry. We show that, if the state maintains industrial employment despite import liberalisation, through cheaper credit to firms, then employer evasion will increase, due to a rise in the formal-informal wage gap. Institutional delays in punishment of employer evasion generate this outcome. Greater employer evasion will entail greater diversion of resources to employer-union conflicts. To moderate such waste, the state must attenuate its role as the enforcer of contracts between unions and employers, thereby reducing the total income of workers, and, paradoxically, firms’ profits. Our results explain observed trends in developing countries, which are characterised by large informal labour markets. JEL Classification Number: J51, J52, O12, O17.