Effort Observability and Worker Productivity: Towards an Explanation of Economic Dualism

Hadi Esfahani () and Djavad Salehi-Isfahani

Economic Journal, 1989, vol. 99, issue 397, 818-36

Abstract: This paper suggests an explanation of the wage and productivity differentials between formal and informal sectors in developing countries. This explanation is based on differences in the observability of effort that arise from technological differences (such as size of operation). The authors argue that observability of effort is lower in the formal sector and then show that, under reasonable conditions, this leads to higher wages and higher effort (productivity). This is because with lower observability the marginal cost of effort is lower when existing employees are induced to work harder than when more workers are hired. Explanations for intersectoral differences in factor intensities and sector-specific unemployment rates also follow from the authors' basic assumptions. Copyright 1989 by Royal Economic Society.

Date: 1989
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