superior predictive power relative to other methodologies. Furthermore, the results show that average GDP-employment elasticities vary substantially across countries and sectors – ranging between 0.0 and 1.0 for more than 80 percent of countries, and between 0.25 and 0.75 for more than half of countries – in manufacturing and services. Agriculture shows a different pattern: estimated average elasticities show lower values than for manufacturing and services, 60 percent of countries have values less than 0.25 (and negative for about one-third of countries), while only 30 percent of countries have values ranging between 0.25 and 0.75. This is explained largely by the dominance of smallholder farming in agriculture across developing economies, which have in general low productivity and follow different dynamics related to labor demand, compared to other sectors.

In addition to the GDP-employment relationship, there are several studies focused on the relationship between employment levels and labor productivity. One distinct feature highlighted by these studies, in the context of developing countries, is the role of informal employment. Capp et al. (2005), Elstrodt et al. (2002), Farrell (2004), Kenyon et al. (2005), and Palmade (2005) found that informality is among the key factors driving productivity differences between developing and developed countries as it affects investment decisions and reduces growth potential of economies. In this context, increases in GDP can be decomposed into productivity and employment gains (World Bank, 2010). While productivity gains increase wages and could lift people from informal jobs into formal ones, they might not necessarily increase employment. Maloney (2001) and Loayza and Rigolini (2011) found strong and negative relationships between informality and productivity.

To complement the analysis of GDP-employment elasticities, the paper estimates the relationship between labor productivity and informal employment. For this purpose, a consistent measure of informality is used across countries which includes the self-employed and non-paid employees (which can account for more than 60 percent of total employment in low-income countries).<sup>8</sup> This measure is subsequently applied to a new standardized global micro dataset (I2D2) harmonized and assembled by the World Bank Group (see Appendix 1).<sup>9</sup> The empirical results show that an increase in labor productivity is associated with a reduction in informality, consistent with the theoretical model predictions.

> 8 This measure does not comprehensively capture the extent of informal employment in developing countries, as it does not take into consideration those workers who work for informal enterprises or formal enterprises while still maintaining informal employment status. In practice, informality measures vary across developing countries and are heavily influenced by the availability of relevant indicators in labor force surveys. The definition of informality used in this paper has the advantage of being consistent across countries and has been widely adopted in studies that employ cross-country data.

> 9 The I2D2 covers 147 countries and includes agriculture, manufacturing, and services as sectors of occupation. I2D2 distinguishes four employment categories: paid employee, non-paid employee, employer and self-employed.

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