Why do cities with larger populations in developing countries create (proportionally) more formal employment? This paper presents and tests a model where skill diversity increases with working age population size, and urban agglomeration economies result from complementarities at the firm level between workers with diverse skills. Unemployed or self-employed (informal) workers are gradually absorbed by firms as new sectors appear via an evolutionary process of skill recombination by firms. At the sector level, the model predicts slower firm entry and higher wages in more complex sectors. At the city level, it predicts that larger cities create (proportionally) more formal employment and harbor more complex sectors, and that formal employment growth depends on the availability of the skills needed in complex sectors. Consequently, there is no convergence in formal employment rates across cities of different sizes. Since skills are not observable, sector complexity is measured from sector diversity and ubiquity, and skill availability is measured from inter-industry labor transitions. These predictions find strong empirical support when tested with social security data for Colombia for the period 2008-2015.
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Eduardo Lora, currently an Associate Research Fellow at Harvard’s Center for International Development, has been Chief Economist of the Inter-American Development Bank and Executive Director of Fedesarrollo. He is the editor or co-author of more than 30 books on economic and social development in Latin America. He is also the author of the textbook Técnicas de Medición Económica, and a regular columnist in Dinero magazine. He studied at the National University of Colombia and the London School of Economics, where he obtained his Master's degree in Science in Economics in 1982.