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The informal economy and business cycles

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    Abstract

    A vast literature has focused on what causes businesses to move into informality and what is the impact of an enlarging informal sector on growth. This paper shows that the size of the informal economy also affects business cycle volatility. Informal businesses are usually small in size, which not only prevents them from achieving economies of scale and from operating with the right capital/labor mix, but also restricts their access to credit markets. Because firms operating informally lack access to credit markets to neutralize the cash flow squeeze arising during recessions, they are more exposed to fluctuations in economic activity and more likely to fail. Using a Generalized Method of Moments methodology, this paper shows that countries with larger informal economies tend to undergo increased volatility in output, investment and consumption over the business cycle.

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    File URL: http://www.ucema.edu.ar/publicaciones/download/volume11/ferreira.pdf
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    Bibliographic Info

    Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

    Volume (Year): XI (2008)
    Issue (Month): (May)
    Pages: 91-117

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    Handle: RePEc:cem:jaecon:v:11:y:2008:n:1:p:91-117

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    Related research

    Keywords: business cycles; informal sector; legal institutions;

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    Cited by:
    1. Roberto Dell’Anno, 2010. "Institutions and human development in the Latin American informal economy," Constitutional Political Economy, Springer, vol. 21(3), pages 207-230, September.
    2. Catalina Granda-Carvajal, 2011. "Macroeconomic Implications of the Underground Sector: Challenging the Double Business Cycle Approach," Working papers 2011-14, University of Connecticut, Department of Economics.

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