A Theory Of The Informal Sector
In many countries, especially poor countries, a heavy burden of taxes, fees, bureaucratic hassles, and bribes drives many producers into an informal sector. This paper shows that we can attribute the existence of a large informal sector to the fact that, because productive endowments contain important unobservable components, the state cannot adjust the amounts that it extracts from producers in the formal sector finely according to each producer's endowment. Given this fact, we find that if the endowment of well-endowed producers is sufficiently large relative to poorly endowed producers, or if their number is relatively large, or if the quality of public services is sufficiently low, then the state extracts a large enough amount from producers in the formal sector that poorly endowed producers choose to work in the informal sector. This result obtains both for a proprietary state, which maximizes its own net revenue, and for a hypothetical benevolent state, which would maximize total net output. But, we also find that there exist combinations of the distribution of endowments and the quality of public services such that the policies of a proprietary state, but not the policies of a hypothetical benevolent state, would cause poorly endowed producers to work in the informal sector. Copyright 2007 Blackwell Publishing Ltd..
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Volume (Year): 20 (2008)
Issue (Month): 1 (03)
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References listed on IDEAS
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- Marcouiller, Douglas & Young, Leslie, 1995. "The Black Hole of Graft: The Predatory State and the Informal Economy," American Economic Review, American Economic Association, vol. 85(3), pages 630-46, June.
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"The State: Agent or Proprieter,"
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Carnegie-Rochester Conference Series on Public Policy,
Elsevier, vol. 45(1), pages 129-162, December.
- Loayza, Norman A., 1997. "The economics of the informal sector : a simple model and some empirical evidence from Latin America," Policy Research Working Paper Series 1727, The World Bank.
- Herschel I. Grossman & Suk Jae Noh, 1990. "A Theory Of Kleptocracy With Probabilistic Survival And Reputation," Economics and Politics, Wiley Blackwell, vol. 2(2), pages 157-171, 07.
- R. Hirschowitz, 1989. "The Other Path: The Invisible Revolution in the Third World," South African Journal of Economics, Economic Society of South Africa, vol. 57(4), pages 266-272, December.
- Grossman, Herschel I. & Noh, Suk Jae, 1994. "Proprietary public finance and economic welfare," Journal of Public Economics, Elsevier, vol. 53(2), pages 187-204, February.
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