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Official Regulations and the Shadow Economy: A Labour Market Approach

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  • Maxim Bouev

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Abstract

This work revisits the role of regulations in emergence o f the shadow economy. In particular, it supplements the previous theoretical research that mainly ignored the fact that the decision to “go underground” is essentially a result of both employers and employees interacting in the labour market. We adapt a job search approach (see, e.g. Acemoglu 2001) to model a transitional economy with an informal sector. We apply and develop the idea first documented inter alia by Loayaza (1996) that there are two types of regulations that influence the size of the informal labour market through two different channels. Red tape and bureaucratic extortion (bribing) make starting a new business officially a not very attractive option and can lead new firms to the informal sector. On the other hand, taxes and redundancy pay make official firms offer lower wages which drives potential employees away into underground jobs. Depending on various combinations of policy parameters equilibria with different share of the informal economy are possible. The paper draws conclusions regarding the role of unemployment benefits in reducing the size of the informal economy. Policy implications are offered.

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Bibliographic Info

Paper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number 524.

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Length: 39 pages
Date of creation: 01 Dec 2002
Date of revision:
Handle: RePEc:wdi:papers:2002-524

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Keywords: informal economy; labour markets; corruption; regulations; search models;

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References

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Citations

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Cited by:
  1. Gaetano Lisi & Maurizio Pugno, 2009. "Entrepreneurship and the Hidden Economy: an Extended Matching Model," Working Papers, Universita' di Cassino, Dipartimento di Scienze Economiche 2009-04, Universita' di Cassino, Dipartimento di Scienze Economiche.
  2. Lisi, Gaetano, 2011. "Matching Models of Equilibrium Unemployment: An Overview," MPRA Paper 30191, University Library of Munich, Germany.
  3. Lisi, Gaetano, 2010. "The unemployment volatility puzzle: the role of the underground economy," MPRA Paper 22689, University Library of Munich, Germany.
  4. Maxim Bouev, 2005. "State Regulations, Job Search and Wage Bargaining: A Study in the Economics of the Informal Sector," William Davidson Institute Working Papers Series, William Davidson Institute at the University of Michigan wp764, William Davidson Institute at the University of Michigan.
  5. Feldmann, Horst, 2009. "Business regulation, labor force participation and employment in industrial countries," Journal of Economics and Business, Elsevier, Elsevier, vol. 61(3), pages 238-260.
  6. Bosch, Mariano & Esteban-Pretel, Julen, 2012. "Job creation and job destruction in the presence of informal markets," Journal of Development Economics, Elsevier, Elsevier, vol. 98(2), pages 270-286.
  7. Lisi, G., 2011. "Entrepreneurship, On-the-job Search and Informal Jobs," Journal of the New Economic Association, New Economic Association, New Economic Association, issue 9, pages 33-46.
  8. Gaetano Lisi, 2010. "The Strange Case of Dr. “Unemployed” and Mr “Hidden” in Italy," Economics Bulletin, AccessEcon, vol. 30(4), pages 2802-2816.
  9. Koziarivska Larysa & Oliinyk Andrii, 2006. "Effects of the 2004 Personal Income Tax System Reform on the Shadow Sector in Ukraine," EERC Working Paper Series 06-08e, EERC Research Network, Russia and CIS.
  10. Lisi, Gaetano & Pugno, Maurizio, 2011. "The Underground Economy in a Matching Model of Endogenous Growth," MPRA Paper 31312, University Library of Munich, Germany.
  11. Horst Feldmann, 2008. "Business regulation and labor market performance around the world," Journal of Regulatory Economics, Springer, Springer, vol. 33(2), pages 201-235, April.
  12. Mariano Bosch, 2006. "Job Creation and Job Destruction in the Presence of Informal Labour Markets," CEP Discussion Papers, Centre for Economic Performance, LSE dp0761, Centre for Economic Performance, LSE.
  13. Lisi, Gaetano, 2010. "Introduzione allo studio dei modelli di "matching" del mercato del lavoro
    [Introduction to the study of matching models of unemployment]
    ," MPRA Paper 22735, University Library of Munich, Germany.
  14. Lisi, Gaetano, 2010. "Optimal taxation and monitoring in an economy with matching frictions and underground activities," MPRA Paper 27701, University Library of Munich, Germany.
  15. Mariano Bosch & Julen Esteban-Pretel, 2009. "Cyclical Informality and Unemployment," CIRJE F-Series, CIRJE, Faculty of Economics, University of Tokyo CIRJE-F-613, CIRJE, Faculty of Economics, University of Tokyo.

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