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Official Regulations and the Shadow Economy: A Labour Market Approach

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Author Info
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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Paper provided by William Davidson Institute at the University of Michigan Stephen M. Ross Business School 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
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Handle: RePEc:wdi:papers:2002-524

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Related research
Keywords: informal economy labour markets corruption regulations search models

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Find related papers by JEL classification:
H26 - Public Economics - - Taxation, Subsidies, and Revenue - - - Tax Evasion
J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
J42 - Labor and Demographic Economics - - Particular Labor Markets - - - Monopsony; Segmented Labor Markets
J64 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - Unemployment: Models, Duration, Incidence, and Job Search
O17 - Economic Development, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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References listed on IDEAS
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    Other versions:
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    Other versions:
  3. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, vol. 66(2), pages 293-312, November. [Downloadable!] (restricted)
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    Other versions:
  5. Kolev, Alexandre, 1998. "Labour Supply in the Informal Economy in Russia during Transition," CEPR Discussion Papers 2024, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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    Other versions:
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  18. Acemoglu, Daron & Shimer, Robert, 2000. "Wage and Technology Dispersion," Review of Economic Studies, Blackwell Publishing, vol. 67(4), pages 585-607, October.
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  20. Friedrich Schneider & Dominik H. Enste, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March. [Downloadable!] (restricted)
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    Other versions:
  24. Chander, Parkash & Wilde, Louis, 1992. "Corruption in tax administration," Journal of Public Economics, Elsevier, vol. 49(3), pages 333-349, December. [Downloadable!] (restricted)
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    Other versions:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Mariano Bosch, 2006. "Job Creation and Job Destruction in the Presence of Informal Labour Markets," CEP Discussion Papers dp0761, Centre for Economic Performance, LSE. [Downloadable!]
  2. 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. [Downloadable!]
  3. 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 wp764, William Davidson Institute at the University of Michigan Stephen M. Ross Business School. [Downloadable!]
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