The paper attempts to find out the relationship between informal wage and innovative efforts of firms in the formal sector in countries such as India, where informal sector captures lion's share of total workforce. A firm employs both formal and informal workers to produce a good. In equilibrium both in-house production and outsourcing are opted for. We show that the availability of low wage informal workers makes the formal segment less efficient by reducing its incentive for R and D. Thus countries with vast segment of lowly paid informal workers will also exhibit lowly productive formal sector workers.