Informal employment dynamics in Ukraine: An analytical model of informality in transition economies

• Author: Natalia ISACHENKOVA,Yulia RODIONOVA,Simon COMMANDER
• Date: 01 December 2013
• Published date: 01 December 2013
• DOI: http://doi.org/10.1111/j.1564-913X.2013.00188.x

International Labour Review, Vol. 152 (2013), No. 3–4

Copyright © The authors 2013

Journal compilation © International Labour Organization 2013

Informal employment dynamics in Ukraine:

An analytical model of informality

in transition economies

Simon COMMANDER,* Natalia ISACHENKOVA**

and Yulia RODIONOVA***

Abstract. The transition economies of the former Soviet Union have experienced

a surge of informal employment since the 1990s. This trend, the authors argue, is

driven by the structure of labour compensation inherited from central planning.

Their innovative theoretical model centres on worker choices of full-time and/or

part-time employment across formal, informal and mixed formal-informal sec-

tors. Factoring in the probability of payroll tax evasion detection and the non-

monetary benets provided by state-owned/privatized rms, it suggests that such

benets incentivize workers to combine formal and informal employment. This

is conrmed empirically by panel data evidence from the Ukraine Longitudinal

Monitoring Surveys.

I

nformal employment in rms whose transactions are unregistered for tax or

social security purposes has long been seen as a characteristic of develop-

ing countries.

1

But the 1990s and 20 00s witnessed striking growth of the infor-

mal economy in the transition countries as well: by the mid–1990s, it accounted

* European Bank for Reconstruction and Devleopment, email: CommanderS@ebrd.

com. ** Faculty of Business and Law, Kingston University, London, email: N.Isachenkova@king

ston.ac.uk. *** Faculty of Business and Law, De Montfort University, Leicester, email: yrodionova@

dmu.ac.uk. The authors are grateful to Hartrmut Lehmann for providing the ULMS data and to

Suren Basov, Randolph Bruno, Xiao Chen, Sam Fankhauser, Anthony Ferner, Björn Gustafsson,

Hsueh-Ling Huynh, Iraj Hoshi, Stanislav Kolenikov, Hartrmut Lehmann, Sergey Ljubownikow, Anna

Lukyanova, Tomek Mickiewicz, Alexander Muravyev, Sophia Rabe-Hesketh, Monder Ram, Peter

Rodgers, Sergei Roschin, Andrei Tolstopiatenko, Natalia Vershinina, Tolga Yuret, and participants

in the research seminars and conferences held at EBRD, IZA, London Business School, Oxford

University, Staffordshire Business School, and LIRT-Higher School of Economics in Moscow, for

helpful comments and discussions. Earlier drafts of this article were presented at the IZA-EBRD

Conference on Labour Market Dynamics: Role of Institutions and Internal Labour Markets, held

at the University of Bologna, on 5–8 May 2005; at the LIRT-HSE seminar in the spring of 2009;

at an IZA Topic Week in October 2009; and at ASSA 2010 meetings in Atlanta. The authors also

wish to thank the EBRD and the United Kingdom’s DFID for their support.

Responsibility for opinions expressed in signed articles rests solely with their authors, and

publication does not constitute an endorsement by the ILO.

1

See, for example, Feld and Schneider (2010), Ram, Edwards and Jones (2007), Losby et al.

(2002), Maloney (200 4), Williams (2008 and 2 009), and Williams and Ram (20 09).

International Labour Review446

for 35–44 per cent of GDP in the countries of the former Soviet Union and

21–33 per cent in central and eastern Europe (Bernabè, 2002; Schneider and

Enste, 2000; Yoon et al., 2003; Krstic

´, 2003; Commander and Rodionova, 2005).

In Ukraine, the case study focus of this article, estimates based on macro-

economic aggregates such as electricity consumption or money demand show

that the informal economy grew from 16 to 45–55 per cent of GDP during

the 1990s (Johnson, Kaufmann and Shleifer, 1997; Lacko

´, 2000; Dzvinka, 2002;

Schneider and Enste, 2000; Schneider, 2004). Our own estimates for 2003–04,

based on unique micro data from the Ukraine Longitudinal Monitoring Sur-

veys (ULMS), put the share of informal employment at 19–24 per cent.2

Attempts to understand why there has been such growth in informal-

ity across the transition economies have mostly emphasized the role of pub-

lic policy. A combination of high payroll tax rates and strict labour regulation

may indeed induce incentives for creating informal jobs (Ulyssea, 2010; Kucera

and Roncolato, 2008).3 Yet, growth of informal employment can also depend

on historically determined institutional factors, such as the size of the informal

economy at the end of the Soviet period (Alexeev and Pyle, 2003). Further-

more, economic marginalization of the population during ineffective reforms,

corruption and poor governance can all cause informal employment to rise

(Round, Williams and Rodgers, 2008). Lastly, an increase in entrepreneurial

activity may also stimulate informal work: by giving access to the resources

of a formal employer, mixed formal-informal employment might mitigate en-

trepreneurial risk, providing invaluable support at an early stage of entre-

preneurship. In Ukraine, aspiring entrepreneurs typically combine informal

commercial pursuits with either formal wage employment or registered self-

employment, but upon establishing viable unregistered businesses they tend

to view the latter as more attractive and eventually switch fully to the infor-

mal occupation (Williams, 2008 and 2009). Previous research has also recog-

nized the importance in forming preferences for multiple job holding of the

dynamic interplay between the structure of labour compensation and the level

of outside opportunities, specically unemployment benets and opportunities

for re-employment made available to separated workers (Rein, Friedman and

Wrgtter, 1997; Lehmann, Pignatti and Wadsworth, 2006).

In contrast to previous analytical frameworks, however, this article dis-

tinguishes a mixed, multiple job holding sector from the formal and informal

sectors. Based on this three-sector stylization, we show analytically and empiric-

ally that the structure of labour compensation inherited from central planning

is relevant to the growth of informal employment. We advance the theoretical

analysis of informality by proposing a novel analytical model of an economy

whose workers hold formal, informal or multiple formal-informal jobs and

2 See Lehmann and Terrell (2006) for a description of the ULMS data set.

3 Ukraine’s rate of payroll tax has been set at between 32.6 and 49.7 per cent of wages

since the start of reforms in 1992, although a reduction to 18 per cent is under consideration

(see http://www.kyivpost.com/content/business/payroll-tax-cut-could-reduce-gray-economy-boost-

revenues-321316.html).