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Economic Reform, Informal-Formal Sector Linkages and Intervention in the Informal Sector in Developing Countries: A Paradox

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  • Arvin-Rad, Hassan

    () (University of Illinois at Urbana-Champaign)

  • Basu, Arnab K.

    () (College of William and Mary)

  • Willumsen, Maria

    () (Florida International University)

Abstract

Within a general equilibrium framework of a developing economy with a foreign owned factor of production, this paper questions whether the informal-formal sector relationship is pro-cyclical/ complementary – expansion or contraction in one necessarily implies an expansion or contraction in the other – when the informal sector is subject to a technological shock. We derive a necessary and sufficient condition under which a positive shock to the informal sector results in a contraction in both the size of the urban formal sector and the informal sector. Thus, although our result shows that the informal-formal sector relationship is pro-cyclical, it nevertheless calls into question the conventional wisdom on the benefits of intervention in the informal sector of developing economies, particularly where multinational corporations sub-contract certain labor intensive stages of production to the informal sector.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 5229.

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Length: 19 pages
Date of creation: Oct 2010
Date of revision:
Publication status: published in: International Review of Economics and Finance, 2010, 19, 662-670
Handle: RePEc:iza:izadps:dp5229

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Keywords: Within a general equilibrium framework of a developing economy with a foreign owned factor of production; although our result shows that the informal-formal sector relationship is pro-cyclical; it nevertheless calls into question the conventional wisdom on the benefits of intervention in the informal sector of developing economies; this paper questions whether the informal-formal sector relationship is pro-cyclical/ complementary – expansion or contraction in one necessarily implies an expansion or contraction in the other – when the informal sector is subject to a technological sho; particularly where multinational corporations sub-contract certain labor intensive stages of production to the informal sector.;

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  1. Aureo de Paula & Jose A. Scheinkman, 2007. "The Informal Sector, Second Version," PIER Working Paper Archive 07-035, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 17 Oct 2007.
  2. Chaudhuri, Sarbajit & Yabuuchi, Shigemi, 2007. "Economic liberalization and wage inequality in the presence of labour market imperfection," International Review of Economics & Finance, Elsevier, vol. 16(4), pages 592-603.
  3. Sugata Marjit & Saibal Kar & Hamid Beladi, 2007. "Trade Reform and Informal Wages," Review of Development Economics, Wiley Blackwell, vol. 11(2), pages 313-320, 05.
  4. Aureo de Paula & Jose A Sheinkman, 2007. "The Informal Sector," Levine's Bibliography 122247000000001663, UCLA Department of Economics.
  5. Ronald W. Jones, 1965. "The Structure of Simple General Equilibrium Models," Journal of Political Economy, University of Chicago Press, vol. 73, pages 557.
  6. Marjit, Sugata, 2003. "Economic reform and informal wage--a general equilibrium analysis," Journal of Development Economics, Elsevier, vol. 72(1), pages 371-378, October.
  7. Liimatainen, Marjo-Riitta, 2002. "Training and skills acquisition in the informal sector : a literature review," ILO Working Papers 357120, International Labour Organization.
  8. Chandra, Vandana & Khan, M Ali, 1993. "Foreign Investment in the Presence of an Informal Sector," Economica, London School of Economics and Political Science, vol. 60(237), pages 79-103, February.
  9. Pack, Howard, 1976. "The Substitution of Labour for Capital in Kenyan Manufacturing," Economic Journal, Royal Economic Society, vol. 86(341), pages 45-58, March.
  10. Fields, Gary S., 1975. "Rural-urban migration, urban unemployment and underemployment, and job-search activity in LDCs," Journal of Development Economics, Elsevier, vol. 2(2), pages 165-187, June.
  11. Pedro Amaral & Erwan Quintin, 2004. "The implications of capital-skill complementarity in economies with large informal sectors," Center for Latin America Working Papers 0404, Federal Reserve Bank of Dallas.
  12. Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 1999. "Corruption, public finances, and the unofficial economy," Policy Research Working Paper Series 2169, The World Bank.
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