of efficiency wages. Van Reenan (1996) focuses on the role of innovation and increased labor productivity in generating quasi-rents, which firms can then “share” with workers as efficiency wages. That study presents strong evidence that in British firms workers in firms that adopt more innovative and more productive technologies earn more than identical workers in other firms. It argues that more productive firms allocate part of their “quasirents” from innovation to workers in the form of higher wages. To the extent formal sector firms share quasi-rents with workers, this would contribute to a self-employment and informal sector wage penalty. These penalties would be larger in countries where firms are more productive, and therefore have more quasi-rents to share, and/or in countries in which labor market institutions favor workers in the wage bargaining process.

In one traditional dualistic model of economic development, the formal sector in the least developed countries is small (and self-employment and informal employment are large) because lack of demand, lack of credit, reliable inputs, and export markets keep scale and productivity low for formal sector products (see Lewis, 1954 and La Porta and Schleifer, 2014). For this reason, formal sector firms in low income countries will be less productive. Since firms in low income countries tend to be less productive than those in more developed countries, quasi-rents and therefore self-employment penalties would likely be smaller for workers in low income countries. As demand increases for domestic products and credit, input and export markets expand, the scale of production and productivity increase in the formal sector. As countries develop, firms not only earn more quasi-rents, but labor market institutions may also become more effective in increasing workers’ bargaining power. Both of these factors will lead to increased earnings for formal sector employees relative to the self-employed and informal sector workers.

# **B. Empirical**

This paper contributes to the literature on the estimation of the magnitudes of earnings differentials between self-employed and informal sector employees relative to formal sector and salary employees in developing economies. Many of these studies are based on data from Latin America and the Caribbean and most focus on middle income countries. Almost universally, these studies find that workers in the informal sector earn less than equally qualified employees in the formal sector (i.e. Heckman and Hotz 1986; Gindling, 1991; Basch and Paredes-Molina, 1996; Launov, 2006; and Günther & Launov, 2012). However, not all informal sector workers are self-employed, and the self-employed may be very different from informal sector employees. In a review of the evidence from Latin America, Perry et al. (2007, p.6) conclude that the self-employed voluntarily opt out of the formal sector, while informal salaried workers are queuing for more desirable jobs in either the formal salaried sector or as self-employed workers.

When researchers estimate formal-informal wage differentials separately for informal sector employees and self-employed workers, they typically find different results for the two groups. Compared to formal sector wage and salary employees, Arias and Khamis (2009) find an earnings penalty for informal wage and salary employees but an earnings premium for self-employed workers in Argentina. Nguyen et al. (2013) find the same result in Vietnam. Using quantile regressions, Nguyen et al. (2013) further find that both informal 7