Rural Migrants and Urban Informality: Evidence From Brazil

Overview

Research Question. Does rural-urban migration increase or decrease urban informality, and through what mechanisms — and does the answer depend on the time horizon?

Setting and Data. The paper studies internal migration in Brazil over 2000–2010. The empirical analysis combines: (i) two waves of the Decennial Population Census (2000 and 2010) covering working-age adults (ages 15–64) across 3,548 Minimum Comparable Areas (MCAs); (ii) the universe of formal firms and workers from the matched employer-employee administrative dataset RAIS (1997–2018); (iii) the ECINF informal firm survey (2003); and (iv) the annual National Household Survey (PNAD, 2001–2009) for year-on-year short-run analysis in 700 identifiable municipalities. Internal immigration to the average urban destination was large: 17.6 percent overall over the decade, 7 percent for state-to-state migration.

Empirical Design. The authors use a shift-share instrumental variable (IV) design. The shares are pre-existing migration networks (migrant flows by origin-destination pair, 1995–2000). The shifts are drought shocks constructed from the Standardized Precipitation-Evapotranspiration Index (SPEI) interacted with agricultural crop calendars and the value share of each crop in each origin municipality — accumulated over the 2000–2010 decade. A second independent instrument uses international commodity price shocks as push factors (following a China-analogous construction); the two instruments are nearly uncorrelated across origins (0.007) and only weakly correlated across destinations (-0.3), providing an independent validation.

Long-Run Findings (decadal changes, 2000–2010). A one-percentage-point increase in the immigration rate (equal to 18.5 percent of a standard deviation):

• Increases the share of workers in formal wage employment by 0.27 percentage points (a 1.2 percent increase from the mean of 23 percent).
• Decreases the share in informal wage employment by 0.29 percentage points (a 2.9 percent decrease from the mean of 10 percent).
• Has no effect on overall wage employment, unemployment, or self-employment — the formalization effect is a reallocation from informal to formal jobs, not net job creation.
• Reduces formal sector wages by 0.6 percent, with no effect on informal wages.
• Increases the number of formal establishments by 1.6 percent and the number of formal jobs by 2 percent.
• Raises gross firm entry by 2.8 percent and gross firm exit by 3 percent (higher churn), with effects stable or slightly increasing through 2017–18.

These firm-creation effects are not driven by migrants starting businesses: migrants are not more likely to be business owners in high-immigration municipalities.

Short-Run Findings. Using year-on-year specifications with the PNAD (2001–2009), the authors replicate the results in the prior literature: municipalities receiving more migrants experience a reduction in formal wage employment, with no change in informal employment or non-employment — so the share of informal jobs rises. These short-run informality-increasing effects coexist with the long-run formalization results, and are not a sample artifact (the long-run results are unchanged when restricted to the same 700 PNAD municipalities).

Mechanism — Downward Nominal Wage Rigidity (DNWR). DNWR in the formal sector is the key mechanism reconciling short- and long-run effects. In Brazil, nominal wage cuts were illegal, and the national minimum wage rose regularly during the 2000s. Two municipality-level DNWR proxies are used: (i) the Kaitz index (national minimum wage / municipality median wage in 2000); (ii) the share of workers with negative year-on-year nominal wage changes (from RAIS, 1997–2000). In municipalities with higher DNWR: the positive formalization effects of immigration are smaller or fully muted; non-employment increases; and formal wages decline less. These cross-sectional patterns echo the Harris-Todaro-Fields prediction, and are consistent with DNWR being more binding in the short run (when nominal rigidities bind) than in the long run (when inflation and worker turnover allow real wage adjustment).

Model. The paper develops and estimates a dynamic model of firm dynamics and informality, extending the canonical Hopenhayn framework with (i) two margins of informality — the extensive margin (whether a firm registers) and the intensive margin (whether a registered formal firm hires workers formally) — and (ii) heterogeneous long-run productivity parameters (nu) that generate firm-specific life-cycle growth profiles. Formal firms cannot revert to informality; informal firms can formalize by paying the cost differential between formal and informal entry costs.

Counterfactuals. A simulated once-and-for-all 10 percent labor supply shock (approximately the 80th percentile of observed immigration shocks) produces: a 4.1 percent decline in the share of informal workers (IV: 7.5 percent); a 16.1 percent increase in formal firms (IV: 21.1 percent); and a 3.4 percent wage decline (IV: 5 percent). Of the increase in formal firms, 40 percent is accounted for by formalization of previously informal firms, highlighting the stepping-stone role of informality that a static or dual-economy model would miss. Average firm productivity declines by 1.4 percent due to worsening firm composition (the share of formal firms in the lowest productivity quartile rises by more than 4 percentage points). A counterfactual that nearly eliminates the extensive margin of informality (via steep enforcement costs) raises total output by 8.6 percent vs. 7 percent in the baseline shock, and increases average firm productivity by 2.1 percent vs. a decline of 1.4 percent — at the cost of displacing the least productive informal firms.

Scope Conditions. Results pertain to internal (not international) migration; drought-induced migrants do not change the skill composition of the labor force at destination, justifying a homogeneous worker assumption. The formalization effects hold for migrants and non-migrants separately, and for high- and low-skilled workers separately. The model is calibrated to the average urban destination in Brazil, not a spatial general equilibrium.

Q&A

Q1: What is the identification strategy, and what are the key threats to validity the authors address?

The authors use a shift-share IV where shifts are drought shocks at origin municipalities (constructed from SPEI x crop calendar x crop revenue share, accumulated over 2000–2010) and shares are pre-2000 migration networks. Threats addressed: (i) pre-trends — no evidence of differential pre-trends in firm outcomes between 1997–98 and 1999–2000; (ii) demand channel — controlling for local drought shocks and distance-weighted neighboring shocks leaves results unchanged; (iii) capital reallocation — adding a bank-network-based shift-share control (following prior literature) does not change results; (iv) agricultural processing linkages — results hold after excluding agricultural firms and food/beverage/tobacco manufacturers; (v) migration persistence — controlling for baseline log population and 1995–2000 migration rates leaves results unchanged. The commodity-price-shock instrument provides an independent validation, yielding similar results despite near-zero cross-origin correlation with drought shocks and only -0.3 correlation across destinations.

Q2: How do the authors reconcile the long-run formalization result with the short-run informality-increasing result, and what role does DNWR play?

DNWR is the key mechanism. Nominal wage cuts are illegal in Brazil’s formal sector, and the minimum wage rose through the 2000s, making DNWR binding especially in the short run. In the year-on-year specification (PNAD, 2001–2009), immigration reduces formal wage employment with no change in informal employment, raising the informal share — consistent with prior literature. Over the decade, inflation and worker turnover permit real formal wage adjustment, enabling formal sector expansion. Cross-sectional heterogeneity confirms this: in municipalities with above-median Kaitz index or below-median share of negative wage changes, the formalization effect of immigration is smaller or zero, and non-employment rises — precisely the Harris-Todaro-Fields prediction for rigid-wage environments.

Q3: What is the exact magnitude of the firm-level effects and how persistent are they?

A one-percentage-point increase in the immigration rate increases formal establishments by 1.6 percent, formal jobs by 2 percent, firm entry by 2.8 percent, and firm exit by 3 percent — all decadal effects (1999–2000 to 2011–12). Effects on firms, entry, exit, and jobs remain stable or slightly increasing through 2017–18 as estimated using RAIS panel data, with no evidence of pre-trends (effects near zero in 1997–98 to 1999–2000 period). The effect on firm-level average wages is negative (consistent with the worker-level wage effect) but not statistically significant.

Q4: Are migrants themselves the source of new formal firm creation?

No. The authors directly test and reject this channel. Migrants are not more likely to be business owners — either of small firms (fewer than 5 employees) or larger firms (6 or more employees) — in municipalities that receive more immigration. The increase in formal firm entry is driven by non-migrants responding to cheaper labor.

Q5: What are the two margins of informality in the model, and why does the intensive margin matter for the migration-formality nexus?

The extensive margin is whether a firm registers formally (firm-level binary). The intensive margin is whether a formally registered firm hires workers without formal labor contracts (worker-level, within formal firms). The intensive margin is crucial because it links formal firms to migrants: newly arrived migrants may take informal jobs within formal firms, allowing formal firm creation to respond to the immigration shock even before the labor market fully formalizes. In the transition dynamics after an immigration shock with DNWR, new formal firms tend to be small and lower-productivity, and hire a substantial fraction of their workforce informally — so labor informality hovers near its initial level for several years even as firm informality declines quickly.

Q6: What fraction of the increase in formal firms in the counterfactual comes from stepping-stone formalization versus new formal entry?

In the baseline 10 percent labor supply counterfactual, approximately 40 percent of the increase in the number of formal firms comes from formalization of previously informal firms across their life cycles. The remaining 60 percent comes from new formal firm creation. A static framework would miss the stepping-stone channel entirely and substantially underestimate total formalization.

Q7: How does the model’s calibration pin down the cost structure of informal vs. formal firms?

The model is calibrated using a two-step minimum distance procedure. First-step parameters include the persistence of formal firms’ productivity process (estimated from RAIS: rho_f = 0.92), and statutory tax rates (payroll tax tau_w = 0.375; revenue VAT tau_y = 0.293). Second-step parameters (12 total, including entry costs, exogenous death rates, productivity dispersion, and cost-function curvatures for both margins of informality) are estimated by minimizing the distance between simulated and observed moments from RAIS (2003 cross-section for static moments; 2000–2011 panel for growth moments) and ECINF (informal firms with up to 5 employees, 2003). Key calibrated values: formal entry costs are more than twice informal entry costs and correspond to over 30 times the 2003 monthly national minimum wage; the informal sector exogenous death rate (delta_i = 0.148) is more than twice the formal rate; productivity variance and persistence are similar across sectors.

Q8: What happens to firm productivity and output per worker in the long-run counterfactual?

Average firm productivity declines by 1.4 percent despite lower informality. The composition of formal firms worsens: the share of firms in the lowest productivity quartile rises by more than 4 percentage points, while the share in the top quartile falls by about 3 percentage points. Total output and tax revenues increase (7 and 8.6 percent, respectively), but both decline in per capita terms. The authors note these are likely lower bounds because the model assumes no technological differences between formal and informal sectors and no differential capital access.

Q9: What does the enforcement counterfactual reveal about the dual role of informality?

When the extensive margin of informality is nearly shut down (by making the informal cost function very steep), a 10 percent labor supply shock produces: output increase of 8.6 percent (vs. 7 percent with informality present); average firm productivity increase of 2.1 percent (vs. decline of 1.4 percent); much higher tax revenues due to greater formality. However, this comes at the cost of a sizable reduction in total firm count as the least productive informal firms are displaced. This illustrates the dual role: in the short run, the informal sector acts as an employment buffer and stepping-stone, which is more important when formal wage rigidity is stronger; but in the long run, it dampens aggregate economic benefits from immigration by sheltering low-productivity firms.

Q10: Do the results hold for both migrants and non-migrants, and across skill levels?

Yes. Appendix results show similar employment and wage effects for migrants and non-migrants separately, though formal wage declines are more pronounced for non-migrants. Results are also similar for high- and low-skilled workers — which the authors attribute to the fact that drought-induced migration does not change the skill composition of the workforce at destination (confirmed empirically). Price-shock-induced migrants differ: they are more likely to be young and male, and do change workforce composition, providing a different set of compliers that strengthens external validity.

Q11: How does the paper relate to the “startup deficit” literature on demographic decline?

The paper’s findings are the mirror image of the US startup deficit literature, which argues that demographic slowdown reduced firm entry, labor reallocation, and employment growth. The magnitudes are comparable in scale: the US startup deficit corresponds to a 5-percentage-point decline in firm entry between 1980 and 2012, while the rural-urban migration shocks studied here produce first-order effects on firm entry of similar or larger magnitude (2.8 percent per percentage point of immigration rate), suggesting labor supply growth is a primary driver of formal firm dynamics in both directions.

Key Concepts

Downward Nominal Wage Rigidity (DNWR). In the paper’s usage, the binding constraint that formal sector wages cannot be cut in nominal terms — in Brazil, both legal prohibition of nominal wage cuts and a rising national minimum wage. DNWR is the paper’s central mechanism explaining why immigration increases informality in the short run (wages cannot adjust) but reduces it over the decade (inflation and turnover permit real adjustment). Measured empirically via the municipality-level Kaitz index (national minimum wage / local median wage) and via the share of workers with negative year-on-year nominal wage changes in RAIS.

Extensive Margin of Informality. Whether a firm is registered with the government (formal) or not (informal). In the model, informal firms can avoid taxes but face a size-increasing cost of informality and the option to formalize by paying the difference in entry costs. This margin captures the firm’s legal registration status.

Intensive Margin of Informality. Whether a formally registered firm hires individual workers with or without formal labor contracts (signed work booklet, carteira de trabalho). Formal firms face increasing costs for informal hiring but exploit this margin for lower-cost labor, especially when small or young. This margin is critical because it links formal firms to migration-induced informal labor supply and allows formal firms to absorb migrants before full wage adjustment occurs.

Stepping-Stone Role of Informality. The paper’s term for the dynamic channel through which the informal sector facilitates transitions to formality for both firms and workers. Informal firms accumulate productivity experience and formalize when productivity crosses the formalization threshold; informal workers within formal firms transition to formal contracts as firms grow. In the counterfactuals, 40 percent of the increase in formal firms following a labor supply shock is attributable to this channel. The stepping-stone role is most valuable during the short-run period of formal wage rigidity.

Shift-Share Instrumental Variable. The identification design combining pre-existing migration network shares (fraction of prior migrants to destination d from each origin o, computed 1995–2000) with exogenous push shocks at origin (drought shocks or commodity price shocks). The instrument predicts which destination municipalities receive more migrants based purely on exogenous origin-level shocks, purging the endogeneity from migrants self-selecting into prosperous cities.

Minimum Comparable Area (MCA). The paper’s geographic unit of analysis: a harmonized aggregation of Brazilian municipalities whose administrative borders changed during the study period, yielding 3,548 stable units covering all urban destinations studied. The authors call these “municipalities” for convenience.

Harris-Todaro-Fields Framework. The theoretical benchmark against which the paper’s results are compared — the view (from Harris and Todaro 1970 and Fields) that rural-urban migration increases urban unemployment or informality because DNWR prevents the formal sector from absorbing migrants, who instead queue for formal jobs or enter the informal sector. The paper shows this prediction holds in the short run and in high-DNWR municipalities, but not in the long run where real wage adjustment occurs.