Are Informal Workers Compensated for the Lack of Fringe Benefits? Free Health Care as an Instrument for Formality

This paper estimates the e¤ect of having a job covered by social security, on the wages of female salaried workers. I overcome the heterogeneity bias that typically contaminates estimates by using the exogenous availability of free health care and prescription drugs implemented in 2001 in the part of Mexico City that belongs to Distrito Federal (DF). This program provides valid instruments because health care is a substantial component of the bene?ts provided by social security, so the availability of alternative free health care should decrease the incentive to contribute to the system. In addition, eligibility for this program is not correlated with individual unobserved characteristics that a¤ect either wages or the choice of sector. My results show that being a DF resident after free health care was implemented has a negative an signi?cant e¤ect on the probability that a female salaried worker has social security in her current job. Regarding wages, not controlling for the endogeneity of formality on the wage regression gives rise to a positive formal premium as in previous studies for both developed and developing countries. In contrast, my instrumental variables results show that female salaried workers in the formal sector earn between 16 to 23 percent less than female workers in informal jobs. These results show that workers who receive higher fringe bene?ts are paid a lower wage, which supports the compensating di¤erential theory. In the Mexican context, it would also suggest that informal salaried workers are not necessarily worse o¤than their counterparts in the formal sector.