Do more flexible labor market regulations reduce informal employment in formal
firms? This paper examines the effects of changes in labor regulations on the
incidence of formal employment. Using the case of Egypt, we study the effects of the
introduction of more flexible labor regulations in 2003 on the probability that noncontractual
workers will be granted a formal employment contract. To identify the
effect of the law and control for potential confounding factors, we use a difference-indifference
estimator that measures the difference in the pre and post-law probability
of obtaining a formal contract across a treatment group of non-contractual workers
initially employed in formal firms and a comparison group of non-contractual workers
initially employed in informal firms. The latter serve as a useful comparison group
since informal firms are unlikely to formalize as a result of the law, so that the only
way their workers can become formal is to move to another firm. Our findings show
that the passage of the new labor law did in fact increase the probability of
transitioning to formal employment for non-contractual workers employed in formal
firms by about 3-3.5 percentage points, or the equivalent of at least a fifth of informal
workers in formal firms.