public goods is not conditional upon formal employment and individuals are distanced from the state and government bureaucrats are not accountable to taxpayers.

Finally, high informality could undermine productivity and economic growth. There are potential efficiency losses because of suboptimal production decisions related to scale, investment, the use of technology and innovation. A recent analysis showed that the expansion of informality in Russia was found to have partially reduced the positive contribution to productivity growth of labor reallocation during the period 2002-12 (World Bank, 2016). Firm productivity may be hindered both by limited incentives for investing in training informal workers as well as the selective enforcement of formal regulations.

Rigid labor market institutions could lead to higher informality, but previous studies suggest that a combination of weak enforcement and universal access to basic pension and health care are important drivers of informality in Russia. Stringent labor market institutions can incentivize informal employment if they increase the cost of formal job creation. For example, when minimum wages increased in 2007, subsequent increases in informal employment were observed in Russia (Muravyev & Oshchepkov, 2015). More generally however, contrary to the widely held belief that Russia had very rigid employment protection legislation (EPL), internationally comparable estimates showed that Russia’s labor law is not particularly restrictive (Lehmann, Muravyev, Razzolini, & Zaiceva, 2013) and (World Bank, 2018). Notably, institutional stringencies appear to have shaped the particular labor market adjustment model observed in Russia. That is, the Russian labor market responds to output falls during economic crises more through lower wages and hours of work, rather than less employment. This is made possible by low minimum wages, low unemployment benefits and weak enforcement of wage and employment regulations, that altogether support flexible wages and flexible working hours (Gimpelson & Kapeliushnikov, 2011). Moreover, there is evidence of limited, or irregular, enforcement of labor law regulations: _“...Workload of the inspectorate is considered high. In 2016 in Federal Labor Inspectorate (FLI), the ratio was one inspector per 34,400 employed, while ILO recommends one inspector per 20,000 workers for transition countries. On average, there were 3,730 enterprises per inspector. Current capacity of FLI allows, on average, one inspection in 28 years while ILO recommends, on average, no less than once in 5 years...”_<sup>_5_</sup> The combination of a weak regulatory environment and low unemployment benefits makes informal employment an attractive option, especially in Russia where access to basic pension and health care is weakly dependent upon formal employment. (Gimpelson & Kapeliushnikov, 2014) argue that there is, in addition, a political economy challenge: as informality grows as a consequence of regulatory failure, a vicious circle of more regulatory failure and more informality leads to a weakening of the social contract.

> 5 <u>(World Bank, 2018), page 11.</u>

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