activity and whether their pension contributions were paid. This allows us to define an informal sector comprising of two groups: (i) unpaid, contributing family members, farmers on own farm, and workers engaged in other activity (such as sale of agricultural products); (2) workers not employed in the public sector or in international organization and whose pension contributions were not paid. This definition is consistent with the 2002 BH labor market study (World Bank 2002).

Using this working definition, the BH labor market may then be characterized by a duality of a rigid formal labor market dominated by large and state-owned enterprises and a flexible informal labor market dominated by micro-enterprises (those with fewer than 10 employees), typically in the low-productivity agricultural sector. Between 2001 and 2004, the share of informal sector employment in total employment grew, from 37 percent to 42 percent.<sup>7</sup> While the share of informal sector employment grew in both entities, the informal sector now accounts for close to half of all employment in the Republika Srpska (RS).

Informal sector employment is predominantly in agriculture, followed by construction and manufacturing (Figure 1). Over the last four years, the share of construction sector employment in total informal sector employment has fallen slightly while the manufacturing sector share has increased. Self-employment accounts for a steadily increasing share of total informal employment. In 2001, it accounted for 29 percent of total informal sector employment. Currently it represents over 34 percent.

What are the covariates of informality? Education is negatively related to the probability of informal sector employment, and has become more so over time. Age is nonlinearly related to informality: The incidence of informal sector employment is initially high among younger workers; it then falls steadily until about age 44, at which point it starts rising again.

# _Wage Outcomes_

Over the last four years, wages increased in real terms across the wage distribution, except for the highest paid workers. Figure 2 depicts average real net monthly earnings by earnings deciles for a sample of employed workers drawn from panel observations, based on their observed earnings in 2001. The empirical evidence suggests that in general, <!-- Start of picture text --> Figure 2. Real Net Monthly Earnings by Earnings Decile<br>1000<br>900 Decile 10<br>800<br>700<br>600<br>500 Decile 9<br>Decile 8<br>400 Decile 7<br>300 Decile 6Decile 5<br>200 Decile 4Decile 3<br>Decile 2<br>100 Decile 1<br>0<br>2001 2002 2003 2004<br>Source: LSMS and staff estimates.<br>Note: Wage deciles are based on the distribution of net monthly earnings in 2001. The sample is restricted to panel<br>observations who were employed in 2001.<br><!-- End of picture text -->

> 7 The BH labor market study found that informal sector employment accounted for 36 percent of total employment in 2001 (World Bank 2002). The growth of the informal sector between 2001 and 2002 is also documented in the CEM (World Bank 2005a). The relative size of the informal sector is consistent with existing estimates of the so-called “grey economy” in percent of GDP (about 40-57 percent) (see for example IMF 2004b; Kadic 2005).

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