where is total employment in the economy, is informal employment, is value added, are IIddII control variables in sector jjHH _j_ and year _t_ , and and jjHH are sector time fixed effects, respectively. For this jjHH jjHH LL LL YY XX estimation informal employment includes those who are self-employed and non-paid employees. jj HH μμ λλ Capturing non-paid employees is important, especially for low-income countries, as their number can reach more than 60 percent of total employment in countries such as Liberia, as well as in the agriculture sector where labor activities for smallholder farming are spread among household members.<sup>27</sup> Harmonized labor force surveys collected by the World Bank are used to derive a measure of the informal sector for this estimation, substantially expanding the sample size and including countries outside the Latin America and Caribbean region, when compared to other studies. The sample includes 87 countries, where each country has more than one survey (see Appendix 1).<sup>28</sup> Labor productivity is measured as a logarithm of the value added of the sector in constant prices divided by the number of total (formal and informal) workers.

The empirical results in Table 2 are in line with the theoretical model and the stylized facts discussed above, showing that productivity growth is associated with a decrease in informal employment across the three sectors considered (agriculture, manufacturing, and services). These results are consistent with Maloney (2001) and Loayza and Rigolini (2011). Columns (1)-(3) provide estimates for equation (14) without control variables for the three sectors, while columns (4)-(6) show regression results with control variables, such as export and import shares in GDP, human capital, the dependency ratio, the real interest rate, the log of population, and country fixed effects. The regression results indicate that there is a significant negative relationship between labor productivity and share of informal employment across all sectors; and the results hold in both specifications – with and without the use of control variables. This confirms that enhancements in labor productivity are associated with reduced informality and higher

> 27 Informal employment using this definition differs from the ILO’s reported statistics on informality as the latter includes other types of informal workers, such as paid workers who work for either formal or informal sectors. Country-specific employment informality definitions are based on the data availability about job characteristics, such as having a remuneration, contract, and social security among other benefits. Since the coverage and quality of data vary significantly across countries, this paper uses a definition that can be harmonized across countries. While this definition does not capture the entire informal sector, it allows to measure informality in a comparable way; and improves over previous definitions used by other studies like Maloney (2001) and Loayza et al. (2011) which only include self-employed workers.

> 28 It is worth noting that in high-income countries, the self-employed are not necessarily part of the informal economy. Rather, they reflect economic inefficiencies or low productivity of workers that can be improved with more capital and economies of scale, ultimately affecting an overall aggregate productivity at the sector level.

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