Productivity and wage gaps between informal and formal firms in India: Trends and determinants

This study examines the productivity and wage gaps between informal and formal sector firms in India. Using a comprehensive dataset covering a 15-year period, we explore the influence of access to finance, infrastructure, and labor regulations on these gaps. Employing standard Oaxaca decomposition method, we analyze the role of these factors in explaining the informal-formal gaps in wages and productivity. Our results reveal significant and expanding gaps in both productivity and wages between informal and formal firms. Decomposition analysis suggests firm characteristics and infrastructure as primary factors widening the gaps, while access to finance and flexible labor regulations help narrow them. The findings point to the importance of targeted interventions needed to augment the growth and development of the informal manufacturing sector. Policies that enhance access to finance, improve infrastructure, and promote favorable labor markets can contribute to narrowing the gaps.