Abstract
Many developing economies share two distinctive features: high levels of income inequality and sizeable informal employment. Despite the importance of these facts, the literature addressing the relationship between both variables is scarce, especially for Latin America, a region characterized by these two distinctive features. In this paper, we propose a simple framework that illustrates their ambiguous relationship: an increase in the level of formalization in the labour market can have different effects on labour income inequality. Different factors, such as the income differential between formal and informal workers, the level of inequality within each sector, and the size of the informal employment may affect the sign of the relationship between inequality and informality. We empirically test this relationship using panel data for Latin American countries, covering the period 1990-2018. Our results indicate that, for the specific conditions that held for that region and period, formalization in the labour market has shown a positive association with labour income equality.