Labor-Law compliance in an informal labor market

I study the effec t s of a reform of the system of labor inspection in Colombia, which was requested by the United States as part of the negotiations for a bilateral trade agreement. An additional labor inspector increases labor-law compliance in the formal sector (i.e., among registered firms), while there is no effect in the informal sector. There is also a decrease in the probability of working informally in the formal sector, while overall employment remains unchanged. Complementary evidence from an enterprise survey shows that firms in the formal sector compensate for part of the increase in labor costs by reducing payroll contributions.