We express a doubt on the conventional wisdom namely, of a positive relationship between wage and productivity, of a formal sector firm in a developing economy where the firm can either go for subcontracting to the informal sector to minimize wage cost along with apprehension of extra-legal cost and/or investment in R&D for in-house production. We show that a rise of the formal wage does not necessarily ensure higher R&D and labour-productivity of the formal firm while a rise of the informal sector wage must improve R&D and the resultant labour-productivity in the firm. Thus countries with a vast segment of lowly-paid informal workers will also exhibit lowly-productive formal sector workers.
INFORMAL WAGE AND FORMAL SECTOR PRODUCTIVITY: THEORY AND EVIDENCES FROM INDIA
Working Paper Series No. E/301/2009