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Is the devil in the shadow? The effect of institutional quality on income

Author

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  • Israt Jahan
  • Jamie Bologna Pavlik
  • Ryan Blake Williams

Abstract

The positive relationship between institutional quality and “official” income is well documented. It is unclear, however, whether this relationship holds once the “unofficial” economy is accounted for. An improvement in institutional quality tends to shift production out of the shadow and into the official sector, resulting in an increase in official income. However, this shift comes at the expense of the informal economy, potentially negating the perceived gains in output. This paper uses data from 5,506 Brazilian municipalities to explore the effects of institutional quality on total income per person. We additionally estimate the effect of institutions on informal sector size. Our most robust finding suggests that higher‐quality institutions using our broadest measure are significantly related to development. While good institutions do decrease the size of the informal sector, the consequential switch to formality raises overall productivity.

Suggested Citation

  • Israt Jahan & Jamie Bologna Pavlik & Ryan Blake Williams, 2020. "Is the devil in the shadow? The effect of institutional quality on income," Review of Development Economics, Wiley Blackwell, vol. 24(4), pages 1463-1483, November.
    • Handle: RePEc:bla:rdevec:v:24:y:2020:i:4:p:1463-1483
    DOI: 10.1111/rode.12691
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    2. Victor Frimpong, 2025. "When Institutions Cannot Keep up with Artificial Intelligence: Expiration Theory and the Risk of Institutional Invalidation," Administrative Sciences, MDPI, vol. 15(7), pages 1-22, July.
    3. William Y. N. Suzuki & Marcio P. Laurini & Luciano Nakabashi, 2022. "Spatial heterogeneities, institutions, and income: Evidence for Brazil," Papers in Regional Science, Wiley Blackwell, vol. 101(3), pages 537-571, June.
    4. Luciano Nakabashi & Ana Elisa Pereira, 2023. "Factors of production, productivity, institutions, and development: Evidence from Brazil," Review of Development Economics, Wiley Blackwell, vol. 27(2), pages 1034-1055, May.
    5. Zuocheng Chen & Krishna P. Paudel & Stephen Devadoss, 2024. "Economic openness, financial bias, and the urban–rural income gap," Review of Development Economics, Wiley Blackwell, vol. 28(1), pages 242-263, February.
    6. Ozer, Yusuf, 2022. "Informal Sector and Institutions," MPRA Paper 114755, University Library of Munich, Germany.

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