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Trade and Domestic Distortions: the Case of Informality


  • Rafael Dix-Carneiro
  • Pinelopi K. Goldberg
  • Costas Meghir
  • Gabriel Ulyssea


We examine the effects of international trade in the presence of a set of domestic distortions giving rise to informality, a prevalent phenomenon in developing countries. In our quantitative model, the informal sector arises from burdensome taxes and regulations that are imperfectly enforced by the government. Consequently, smaller, less productive firms face fewer distortions than larger, more productive ones, potentially leading to substantial misallocation. We show that in settings with a large informal sector, the gains from trade are significantly amplified, as reductions in trade barriers imply a reallocation of resources from initially less distorted to more distorted firms. We confirm findings from earlier reduced-form studies that the informal sector mitigates the impact of negative labor demand shocks on unemployment. Nonetheless, the informal sector can exacerbate the adverse welfare effects of economic downturns, amplifying misallocation. Last, our research sheds light on the relationship between trade openness and cross-firm wage inequality.

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  • Rafael Dix-Carneiro & Pinelopi K. Goldberg & Costas Meghir & Gabriel Ulyssea, 2021. "Trade and Domestic Distortions: the Case of Informality," NBER Working Papers 28391, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:28391
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    References listed on IDEAS

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    2. Kose, M. Ayhan & Elgin, Ceyhun & Ohnsorge, Franziska & Yu, Shu, 2021. "Growing Apart or Moving Together? Synchronization of Informal and Formal Economy Cycles," CEPR Discussion Papers 16498, C.E.P.R. Discussion Papers.
    3. Wang, Feicheng & Liang, Zhe & Lehmann, Hartmut, 2021. "Import competition and informal employment: Empirical evidence from China," University of Göttingen Working Papers in Economics 426, University of Goettingen, Department of Economics.
    4. Camila Cisneros-Acevedo & Alessandro Ruggieri, 2022. "Firms, policies, informality, and the labour market," Discussion Papers 2022-11, University of Nottingham, GEP.
    5. Peter Levell & Matthias Parey & Aitor Irastorza-Fadrique, 2023. "Household responses to trade shocks," IFS Working Papers W23/13, Institute for Fiscal Studies.
    6. Chacha, Peter Wankuru & Kirui, Benard Kipyegon & Wiedemann, Verena, 2024. "Supply Chains in Times of Crisis: Evidence from Kenya’s Production Network," World Development, Elsevier, vol. 173(C).
    7. Julia Fonseca & Adrien Matray, 2022. "Financial Inclusion, Economic Development, and Inequality: Evidence from Brazil," Working Papers 308, Princeton University, Department of Economics, Center for Economic Policy Studies..
    8. Niklas Engbom & Gustavo Gonzaga & Christian Moser & Roberta Olivieri, 2022. "Earnings inequality and dynamics in the presence of informality: The case of Brazil," Quantitative Economics, Econometric Society, vol. 13(4), pages 1405-1446, November.
    9. Sanjay Jain, 2021. "Informal employment or informal firms? Regulatory enforcement and the transformation of the informal sector," WIDER Working Paper Series wp-2021-123, World Institute for Development Economic Research (UNU-WIDER).
    10. Pavel Chakraborty & Rahul Singh & Vidhya Soundararajan, 2021. "Import Competition, Formalization, and the Role of Contract Labor," Working Papers 332157179, Lancaster University Management School, Economics Department.
    11. Andres García-Suaza & Fernando Jaramillo & Marlon Salazar, 2023. "Tax policies, informality, and real wage rigidities," Documentos de Trabajo 20744, Universidad del Rosario.
    12. Filipe Correia & Gustavo S. Cortes & Thiago C. Silva, 2021. "Is Corporate Credit Risk Propagated to Employees?," Working Papers Series 551, Central Bank of Brazil, Research Department.
    13. Brambilla, Irene & César, Andrés & Falcone, Guillermo & Gasparini, Leonardo, 2023. "The impact of robots in Latin America: Evidence from local labor markets," World Development, Elsevier, vol. 170(C).
    14. Manuel Fernández & Gabriela Serrano, 2022. "New Perspectives on Inequality in Latin America," Documentos CEDE 20295, Universidad de los Andes, Facultad de Economía, CEDE.
    15. Amodio, Francesco & Medina, Pamela & Morlacco, Monica, 2022. "Labor Market Power, Self-Employment, and Development," CEPR Discussion Papers 17543, C.E.P.R. Discussion Papers.
    16. Vrolijk, Kasper, 2023. "How does globalisation affect social cohesion?," IDOS Discussion Papers 5/2023, German Institute of Development and Sustainability (IDOS).
    17. Bachas,Pierre Jean & Fisher-Post,Matthew & Jensen,Anders & Zucman,Gabriel, 2022. "Globalization and Factor Income Taxation," Policy Research Working Paper Series 9973, The World Bank.
    18. Dix-Carneiro, Rafael & Kovak, Brian K., 2023. "Globalization and Inequality in Latin America," IZA Discussion Papers 16363, Institute of Labor Economics (IZA).
    19. Ceyhun Elgin & M. ayhan Köse & Franziska Ohnsorge & Shu Yu, 2021. "Growing Apart or Moving Together? Synchronization of Informal and Formal Economy Cycles Abstract:," Working Papers 2021/04, Bogazici University, Department of Economics.
    20. Paula Bustos & Juanma Castro-Vincenzi & Joan Monràs & Jacopo Ponticelli, 2024. "Industrialization without Innovation," Working Papers 1444, Barcelona School of Economics.
    21. Chakraborty, Pavel & Singh, Rahul & Soundararajan, Vidhya, 2022. "Import Competition, Formalization, and the Role of Contract Labor," IZA Discussion Papers 15760, Institute of Labor Economics (IZA).
    22. Tomasz Serwach, 2022. "The European Union and within-country income inequalities. The case of the New Member States," Working Papers hal-03548416, HAL.
    23. Paula Bustos & Juanma Castro-Vincenzi & Joan Monràs & Jacopo Ponticelli, 2023. "Industrialization without innovation," Economics Working Papers 1888, Department of Economics and Business, Universitat Pompeu Fabra.
    24. Lourenco Paz, 2022. "Does age modulate the impact of import competition on job type?," Economics and Business Letters, Oviedo University Press, vol. 11(4), pages 161-171.

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    More about this item

    JEL classification:

    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F16 - International Economics - - Trade - - - Trade and Labor Market Interactions
    • J46 - Labor and Demographic Economics - - Particular Labor Markets - - - Informal Labor Market
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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