The higher degree of informality in the private sector could play an important role in explaining wage differentials. A comparison between public sector and private sector needs to take into account the issue of the higher degree of informality that exists in the private sector. The analysis of ENAHO data shows that: (i) a large number of individuals working in the private sector do not have a formal contract; (ii) individuals without a formal contract earn much lower salaries. As a consequence, it is important to control for the “informality issue” in order to perform a consistent comparison between public and private sector wages. To address this issue, all the private sector employees without a formal contract have been excluded from the analysis.<sup>8</sup> Therefore, the focus of the analysis will be on the comparison between public sector and formal private sector workers (columns 2 and 4 of Table 1, respectively).<sup>9</sup> Higher levels of education might explain the higher average level of compensation in the public sector. On average, the public sector hires more educated people than the private sector. Based on the sample of ENAHO, more than 60% of public sector workers completed some kind of post-secondary education and only 5.6% of employees did not start a secondary education course. In contrast, the percentage of private sector workers with a post-secondary degree (18.2%) is lower than the share of public sector workers that completed just primary education (21.4%). Interestingly, the average education level of private sector workers improves significantly when we exclude from the sample those workers without a formal contract. A significant part of formal private sector workers (37.5%) achieved a post-secondary education level whereas only 7.5% did not start a secondary education course (see Table 1). People with higher education tend to earn higher wages; average salaries in the public sector may be higher as a result of the differential of the education in the labor forces. To take this issue into account, we distinguished between people with higher or lower education while comparing public and privates sector wages. If higher education is one of the drivers of higher wages in the public sector, wage differentials should shrink once we control for the level of instruction. Results in Figure 2 corroborate this hypothesis.

The analysis of the statistical distributions of compensation for each education levels provides additional information (see Figure 3).<sup>10</sup> The public sector distribution for the three highest

> 8 The issue of formality has been considered under the legalistic definition based on the right to a retirement pension linked to employment. Even if data on the right to a retirement pension are not directly available, the existence of a formal contract between employer and employee is considered to be a reasonable signal of formality.

> 9 The analysis of the distribution of public sector and formal private sector compensation allows to compute and compare wage compression ratios in Peru. The compression ratio, computed as the ratio between the 90<sup>th</sup> percentile and the 10<sup>th</sup> percentile of the population, is much higher in the formal private sector (9.4) than in the public sector (3.1).

> 10 Female and male pay distributions for each education level are presented in Annex 1 (Table A1.2 – Panel A and Panel B).

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