Labor Informality and Credit Market Accessibility

TL;DR

This paper examines how improved credit market access influences workers' transition from informal to formal employment in Russia, highlighting policy implications for reducing informal labor through credit system enhancements.

Contribution

It provides empirical evidence on the impact of credit market development on labor formalization using dynamic multinomial logit models in the Russian context.

Findings

Relaxation of credit constraints increases formalization probability.

Improved credit market access raises formalization chances by 5.4 percentage points.

Better credit access significantly reduces informal employment in credit-constrained areas.

Abstract

The paper investigates the effects of the credit market development on the labor mobility between the informal and formal labor sectors. In the case of Russia, due to the absence of a credit score system, a formal lender may set a credit limit based on the verified amount of income. To get a loan, an informal worker must first formalize his or her income (switch to a formal job), and then apply for a loan. To show this mechanism, the RLMS data was utilized, and the empirical method is the dynamic multinomial logit model of employment. The empirical results show that a relaxation of credit constraints increases the probability of transition from an informal to a formal job, and improved CMA (by one standard deviation) increases the chances of informal sector workers to formalize by 5.4 ppt. These results are robust in different specifications of the model. Policy simulations show strong support for a reduction in informal employment in response to better CMA in credit-constrained communities.