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The dynamics of informal employment

  • Jane Ihrig
  • Karine S. Moe

The informal sector, which produces legal goods but does not comply with government regulations, is a functioning part of all economies, with a proportion of the labor force ranging from 17 percent in OECD countries to 60 percent in developing countries. Using a dynamic model that includes an informal sector, this paper illustrates the natural dynamics of the sector, describes how tax policy affects its size, and quantifies the costs of having it. Simulations yield movements in informal employment and output consistent with empirical observations. We find that the U.S. informal sector accounts for about 5 percent of U.S.labor hours and produces about 3 percent of U.S. GDP in steady state. Strategies for reducing the size of the sector are discussed. We find, however, that the distortion from this sector in terms of lifetime loss in an economy's capital stock, is minimal--supporting those who want to keep the informal sector as a functioning part of society.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 664.

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Date of creation: 2000
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Handle: RePEc:fip:fedgif:664
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  1. Jones, C.I., 2000. "Sources of U.S. Economic Growth in a World of Ideas," Papers 99-29, United Nations World Employment Programme-.
  2. Stephen L. Parente & Edward C. Prescott, 1991. "Technology Adoption and Growth," NBER Working Papers 3733, National Bureau of Economic Research, Inc.
  3. Pierre-Daniel G. Sarte, 1999. "Informality and rent-seeking bureaucracies in a model of long-run growth," Working Paper 99-07, Federal Reserve Bank of Richmond.
  4. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  5. Lucas, Robert E, Jr, 1990. "Why Doesn't Capital Flow from Rich to Poor Countries?," American Economic Review, American Economic Association, vol. 80(2), pages 92-96, May.
  6. R. Hirschowitz, 1989. "The Other Path: The Invisible Revolution in the Third World," South African Journal of Economics, Economic Society of South Africa, vol. 57(4), pages 266-272, December.
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