Informal-sector employment is pervasive in developing economy cities. The informal sector
contributes little to public finance and has low productivity due to the lack of access to trade
support and export market, which is available in the formal sector. We study cross-region
variations in employment formalization within a country in a general equilibrium model
where entrepreneurs in each region choose between the formal and informal sectors by
weighing the benefit of access to export market and the cost of a local business tax. The
model is built on Behrens, Duranton and Robert-Nicoud (2014) to account for (1) skill sorting
across regions; (2) occupation selection in terms of employee, informal-sector entrepreneur,
and formal-sector entrepreneur; and (3) agglomeration economy arising from home-market
effect. We solve for equilibrium employment size and number of entrepreneurs and their skill
mix in both formal and informal sectors in individual regions, subject to perfect labor
mobility and national aggregate employment and skill endowment constraints. The model can
account for the cross-region variations in these equilibrium employment variables observed in
Indonesia during the past two decades. The counterfactual analysis shows how employment
and skills shift between the employment sectors and regions in response to export
improvement and business tax changes.