Matching and Local Labor Market Size in Mexico: The Role of Informality (Revise and Resubmit, 2nd round, Regional Science and Urban Economics)

With Jorge Meléndez and José G. Nuño-Ledesma

Abstract: We examine the relationship between local labor market (LLM) size and the quality of worker-firm matching in Mexico using a matched employer-employee dataset of formal private-sector workers. Estimating two-way fixed effects models of log-wage, we find evidence of a positive assortative matching at the aggregate level. On average, doubling a local labor market’s size increases matching quality by four to seven percentage points. However, labor informality significantly mediates this relationship. Higher informality is associated with lower assortative matching strength and a weaker connection between matching and LLM size. In markets with high informality, we observe that high-performing workers tend to fail to pair with high-performing firms. Furthermore, in these high-informality contexts, increased LLM size fails to translate into the expected matching advantages. Our results provide evidence suggesting that informality acts as a structural friction that prevents the realization of gains typically associated with urban scale in advanced economies.