Economic Reform, Informal-Formal Sector Linkages and Intervention in the Informal Sector in Developing Countries: A Paradox
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 a contraction 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.
|Date of creation:||Oct 2010|
|Publication status:||published in: International Review of Economics and Finance, 2010, 19, 662-670|
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