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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.

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Article provided by Elsevier in its journal International Review of Economics & Finance.

Volume (Year): 19 (2010)
Issue (Month): 4 (October)
Pages: 662-670

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Handle: RePEc:eee:reveco:v:19:y:2010:i:4:p:662-670
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620165

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  6. 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.
  7. 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.
  8. 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.
  9. Aureo de Paula & Jose A. Scheinkman, 2007. "The Informal Sector," PIER Working Paper Archive 07-033, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
  10. Marjit, Sugata, 2003. "Economic reform and informal wage--a general equilibrium analysis," Journal of Development Economics, Elsevier, vol. 72(1), pages 371-378, October.
  11. Ronald W. Jones, 1965. "The Structure of Simple General Equilibrium Models," Journal of Political Economy, University of Chicago Press, vol. 73, pages 557.
  12. Liimatainen, Marjo-Riitta, 2002. "Training and skills acquisition in the informal sector : a literature review," ILO Working Papers 357120, International Labour Organization.
  13. 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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