This paper analyses the emergence of the informal economy in the environment characterised by non-competitive labour markets with wage bargaining. We develop a simple extension of the standard search model à la Pissarides (2000) with formal and informal sectors to show how a government’s auditing of informal firms and barriers to firms’ entry erected in the formal sector by corrupt bureaucracy can make for stable coexistence of formal and informal jobs in the long term. In equilibrium, wage differentials for homogeneous and risk-neutral workers emerge because different types of jobs have different lifetimes and/or have different creation costs. The former are explained by the auditing activities of the government that in the simple set-up destroy informal matches, while keeping formal jobs intact; the latter are due to varying capital costs, or costs associated with red tape and bureaucratic extortion (bribing). Search frictions introduce rent sharing between firms and workers in both formal and informal sectors. This has an important implication for policy making. In particular, we show that if ceteris paribus a firms’ bargaining position vis-à-vis workers is stronger in the formal rather than in the informal sector, governments can afford to appropriate a larger part of a productive match surplus (e.g. by levying higher taxes), without endangering the qualitative outcome in the long run. Rent sharing also implies that both formal and informal sector employees may receive wages above marginal product. We investigate efficiency properties of an equilibrium with formal and informal jobs and discuss the role of the government in creating and eliminating such inefficiencies partially arising from a version of the hold-up problem (Grout, 1984). Some lessons are drawn for normative analyses of policies aimed at reduction of informality in set-ups with non-competitive labour markets. In particular, the conditions are given under which a reduction in size of the informal sector is likely to be detrimental for economic welfare.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
file. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Length: pages Date of creation: 01 Apr 2005 Date of revision: Handle: RePEc:wdi:papers:2005-764
Contact details of provider: Postal: 724 E. University Ave. Wyly Hall, Floor 1, Ann Arbor, Michigan 48109-1234 Phone: 734 615 4566 Fax: (734) 763-5850 Email: Web page: http://www.wdi.umich.edu More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: (Patricia Loh).
References listed on IDEAS 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.:
Simeon Djankov & Rafael La Porta & Florencio Lopez-De-Silanes & Andrei Shleifer, 2002.
"The Regulation Of Entry,"
The Quarterly Journal of Economics,
MIT Press, vol. 117(1), pages 1-37, February.
[Downloadable!] (restricted)
Other versions:
Simeon Djankov & Rafael La Porta & Florencio LopezdeSilanes & Andrei Shleifer, 2000.
"The Regulation of Entry,"
NBER Working Papers
7892, National Bureau of Economic Research, Inc.
[Downloadable!] (restricted)
Djankov, Simeon & La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei, 2001.
"The Regulation of Entry,"
Working Paper Series
rwp01-015, Harvard University, John F. Kennedy School of Government.
[Downloadable!]
Djankov, Simeon & La Porta, Rafael & López-de-Silanes, Florencio & Shleifer, Andrei, 2001.
"The Regulation of Entry,"
CEPR Discussion Papers
2953, C.E.P.R. Discussion Papers.
[Downloadable!] (restricted)
James Andreoni & Brian Erard & Jonathan Feinstein, 1998.
"Tax Compliance,"
Journal of Economic Literature,
American Economic Association, vol. 36(2), pages 818-860, June.
[Downloadable!] (restricted)
Acemoglu, Daron & Shimer, Robert, 1999.
"Holdups and Efficiency with Search Frictions,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(4), pages 827-49, November.
Other versions: