Following trade liberalization, several developing countries experienced a sharp increase in the share of informal manufacturing employment. In this paper, I examine the impacts of trade liberalization on the labor markets of a small open economy, in an environment in which tariffs affect firms' payroll tax compliance decisions. I demonstrate that a reduction in domestic import tariffs reduces the average formal wage and show that the direction of the effect on the share of informal employment depends on the initial labor market conditions. A cut in trading partner import tariffs decreases the share of domestic informal employment and increases the average formal wage. I confirm the model's principal findings empirically, using data from the 1989-2001 Brazilian trade liberalization episode. I find the results robust to endogeneity and self-selection concerns, which are addressed, respectively, using instrumental variable and switching regression approaches.Keywords: Brazil, informal labor markets, payroll tax, trade liberalization. JEL Codes: F1, H2, O17. * This paper is a merged and updated version of the papers 'The effect of trade liberalization on payroll tax evasion and labor informality' and 'The impacts of trade liberalization on informal labor markets: an evaluation of the Brazilian case.'
Several papers have put serious doubt on the validity of the life cycle-permanent income hypothesis. However, a few of them have focused on the reasons behind the failure. In this study, quarterly data from Brazil is used to check whether the rejection of the life cycle hypothesis could be attributed to the presence of either liquidity constraints or Keynesian-type consumers. The findings indicate that neither liquidity constraints nor myopic consumers could generate the finding that consumption is sensitive only to expected income declines. A possible explanation would be that consumers have some kind of loss aversion preference.
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