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Informality Traps


  • Masatlioglu Yusufcan

    () (University of Michigan)

  • Rigolini Jamele

    () (The World Bank)


Despite large deregulation efforts, informal economic activity still represents a large share of GDP in many developing countries. In this paper we look at incentives to reduce informal activity when capitalists in the formal sector regulate entry. We consider a dual economy with a formal sector employing educated workers and an informal sector with unskilled workers. We show that high costs of education make labor migration and profits in the formal sector an increasing function of its size. Therefore, incentives to allow capital to be reallocated to the formal sector increase with the size of the formal economy, and unless the formal sector has reached a "critical mass" countries remain in a highly informal equilibrium. We conclude by reviewing policies that can push countries with large informal economies towards formalization.

Suggested Citation

  • Masatlioglu Yusufcan & Rigolini Jamele, 2008. "Informality Traps," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 8(1), pages 1-24, December.
  • Handle: RePEc:bpj:bejeap:v:8:y:2008:i:1:n:51

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    References listed on IDEAS

    1. Fernandez-Arias, Eduardo & Montiel, Peter, 1997. "Reform and Growth in Latin America: All Pain, No Gain?," Working Papers 244236, Inter-American Development Bank.
    2. Eduardo Fern·ndez-Arias & Peter Montiel, 2001. "Reform and Growth in Latin America: All Pain, No Gain?," IMF Staff Papers, Palgrave Macmillan, vol. 48(3), pages 1-5.
    3. Saint-Paul, Gilles, 2000. "The Political Economy of Labour Market Institutions," OUP Catalogue, Oxford University Press, number 9780198293323, June.
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    Cited by:

    1. Nicoletta Batini & Young-Bae Kim & Paul Levine & Emanuela Lotti, 2009. "Informal Labour and Credit Markets: A Survey," School of Economics Discussion Papers 0609, School of Economics, University of Surrey.
    2. Antonio Báez-Morales, 2015. "“Differences in efficiency between Formal and Informal Micro Firms in Mexico”," IREA Working Papers 201516, University of Barcelona, Research Institute of Applied Economics, revised Jun 2015.
    3. Antonio Baez-Morales, 2015. "“Determinants of Micro Firm Informality in Mexican States 2008-2012”," AQR Working Papers 201509, University of Barcelona, Regional Quantitative Analysis Group, revised Apr 2015.
    4. James Albrecht & Lucas Navarro & Susan Vroman, 2009. "The Effects of Labour Market Policies in an Economy with an Informal Sector," Economic Journal, Royal Economic Society, vol. 119(539), pages 1105-1129, July.
    5. Erol Taymaz, 2009. "Informality and Productivity: Productivity Differentials between Formal and Informal Firms in Turkey," ERC Working Papers 0901, ERC - Economic Research Center, Middle East Technical University, revised Mar 2009.
    6. Daniel Mejía & Carlos Esteban Posada, 2007. "Informalidad: teoría e implicaciones de política," BORRADORES DE ECONOMIA 004024, BANCO DE LA REPÚBLICA.
    7. Unal Zenginobuz & Sumru Altug, 2009. "What has been the Role of Investment in Turkey's Growth Performance?," Working Papers 2009/02, Bogazici University, Department of Economics.
    8. Loayza, Norman V. & Rigolini, Jamele, 2011. "Informal Employment: Safety Net or Growth Engine?," World Development, Elsevier, vol. 39(9), pages 1503-1515, September.
    9. International Finance Corporation & World Bank, 2008. "Doing Business 2009 : Comparing Regulation in 181 Economies," World Bank Publications, The World Bank, number 6313.

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