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Informality and long-run growth

  • Frédéric DOCQUIER


    (FNRS and UNIVERSITE CATHOLIQUE DE LOUVAIN, Institut de Recherches Economiques et Sociales (IRES))

  • Tobias MÜLLER


    (University of Geneva, Switzerland)

  • Joaquín NAVAL


    (Universitat Autònoma de Barcelona, Spain)

One of the most salient features of developing economies is the existence of a large informal sector. This paper uses quantitative theory to study the dynamic implications of informality on wage inequality, human capital accumulation, child labor and long-run growth. Our model can generate transitory informality equilibria or informality-induced poverty traps. Its calibration reveals that the case for the poverty-trap hypothesis is strong: although informality serves to protect low-skilled workers from extreme poverty in the short-run, it prevents income convergence between developed and developing nations in the long run. Sudden elimination of informality would induce severe welfare losses for several generations on the transition path. Hence, we examine the effectiveness of different development policies to exit the poverty trap. Our numerical experiments show that using means-tested education subsidies is the most cost-effective single policy option. However, for longer time horizons, or as the economy gets closer to the poverty trap threshold, combining means-tested education and wage subsidies is even more effective.

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Paper provided by Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES) in its series Discussion Papers (IRES - Institut de Recherches Economiques et Sociales) with number 2013034.

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Length: 40
Date of creation: 23 Dec 2013
Date of revision:
Handle: RePEc:ctl:louvir:2013034
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