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Economic reform, informal-formal sector linkages and intervention in the informal sector in developing countries: A paradox


  • Arvin-Rad, Hassan
  • Basu, Arnab K.
  • Willumsen, Maria


Within a general equilibrium framework of a developing economy with a foreign owned factor of production, this paper questions whether the informal-formal sector relationship is pro-cyclical/complementary - expansion or contraction in one necessarily implies an expansion or contraction in the other - when the informal sector is subject to a technological shock. We derive a necessary and sufficient condition under which a positive shock to the informal sector results in an emphcontraction in both the size of the urban formal sector and the informal sector. Thus, although our result shows that the informal-formal sector relationship is pro-cyclical, it nevertheless calls into question the conventional wisdom on the benefits of intervention in the informal sector of developing economies, particularly where multinational corporations sub-contract certain labor-intensive stages of production to the informal sector.

Suggested Citation

  • Arvin-Rad, Hassan & Basu, Arnab K. & Willumsen, Maria, 2010. "Economic reform, informal-formal sector linkages and intervention in the informal sector in developing countries: A paradox," International Review of Economics & Finance, Elsevier, vol. 19(4), pages 662-670, October.
  • Handle: RePEc:eee:reveco:v:19:y:2010:i:4:p:662-670

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    References listed on IDEAS

    1. Aureo de Paula & Jose A. Scheinkman, 2006. "The Informal Sector," Levine's Bibliography 122247000000001030, UCLA Department of Economics.
    2. Marjit, Sugata, 2003. "Economic reform and informal wage--a general equilibrium analysis," Journal of Development Economics, Elsevier, vol. 72(1), pages 371-378, October.
    3. repec:ilo:ilowps:357120 is not listed on IDEAS
    4. Fields, Gary S., 1975. "Rural-urban migration, urban unemployment and underemployment, and job-search activity in LDCs," Journal of Development Economics, Elsevier, vol. 2(2), pages 165-187, June.
    5. Pedro S. Amaral & Erwan Quintin, 2003. "The Implications of Capital-Skill Complementarity in Economies with Large Informal Sectors," Macroeconomics 0309017, EconWPA.
    6. Chaudhuri, Sarbajit & Yabuuchi, Shigemi, 2007. "Economic liberalization and wage inequality in the presence of labour market imperfection," International Review of Economics & Finance, Elsevier, vol. 16(4), pages 592-603.
    7. Liimatainen, Marjo-Riitta., 2002. "Training and skills acquisition in the informal sector : a literature review," ILO Working Papers 993571203402676, International Labour Organization.
    8. Aureo de Paula & Jose A. Scheinkman, 2007. "The Informal Sector, Second Version," PIER Working Paper Archive 07-035, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 17 Oct 2007.
    9. Sugata Marjit & Saibal Kar & Hamid Beladi, 2007. "Trade Reform and Informal Wages," Review of Development Economics, Wiley Blackwell, vol. 11(2), pages 313-320, May.
    10. Ronald W. Jones, 1965. "The Structure of Simple General Equilibrium Models," Journal of Political Economy, University of Chicago Press, vol. 73, pages 557-557.
    11. Chandra, Vandana & Khan, M Ali, 1993. "Foreign Investment in the Presence of an Informal Sector," Economica, London School of Economics and Political Science, vol. 60(237), pages 79-103, February.
    12. Pack, Howard, 1976. "The Substitution of Labour for Capital in Kenyan Manufacturing," Economic Journal, Royal Economic Society, vol. 86(341), pages 45-58, March.
    13. Harris, John R & Todaro, Michael P, 1970. "Migration, Unemployment & Development: A Two-Sector Analysis," American Economic Review, American Economic Association, vol. 60(1), pages 126-142, March.
    14. Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 1999. "Corruption, public finances, and the unofficial economy," Policy Research Working Paper Series 2169, The World Bank.
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    Cited by:

    1. Traoré, Jean Abel & Ouedraogo, Idrissa Mohamed, 2015. "Public policies promoting the informal economy: effects on incomes, employment and growth in Burkina Faso," MPRA Paper 74760, University Library of Munich, Germany.
    2. Dutta, Nabamita & Kar, Saibal & Roy, Sanjukta, 2013. "Corruption and persistent informality: An empirical investigation for India," International Review of Economics & Finance, Elsevier, vol. 27(C), pages 357-373.

    More about this item


    Rural-urban migration Urban informal sector Technological change;

    JEL classification:

    • J8 - Labor and Demographic Economics - - Labor Standards
    • R13 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General Regional Economics - - - General Equilibrium and Welfare Economic Analysis of Regional Economies
    • R23 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Regional Migration; Regional Labor Markets; Population


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