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Informality trends and cycles

  • Loayza, Norman V.
  • Rigolini, Jamele

This paper studies the trends and cycles of informal employment. It first presents a theoretical model where the size of informal employment is determined by the relative costs and benefits of informality and the distribution of workers'skills. In the long run, informal employment varies with the trends in these variables, and in the short run it reacts to accommodate transient shocks and to close the gap that separates it from its trend level. The paper then uses an error-correction framework to examine empirically informality's long- and short-run relationships. For this purpose, it uses country-level data at annual frequency for a sample of industrial and developing countries, with the share of self-employment in the labor force as the proxy for informal employment. The paper finds that, in the long run, informality is larger in countries that have lower GDP per capita and impose more costs to formal firms in the form of more rigid business regulations, less valuable police and judicial services, and weaker monitoring of informality. In the short run, informal employment is found to be counter-cyclical for the majority of countries, with the degree of counter-cyclicality being lower in countries with larger informal employment and better police and judicial services. Moreover, informal employment follows a stable, trend-reverting process. These results are robust to changes in the sample and to the influence of outliers, even when only developing countries are considered in the analysis.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 4078.

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Date of creation: 01 Dec 2006
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Handle: RePEc:wbk:wbrwps:4078
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  1. Sarte, Pierre-Daniel G., 2000. "Informality and rent-seeking bureaucracies in a model of long-run growth," Journal of Monetary Economics, Elsevier, vol. 46(1), pages 173-197, August.
  2. Loayza, Norman V. & Oviedo, Ana Maria & Serven, Luis, 2005. "The impact of regulation on growth and informality - cross-country evidence," Policy Research Working Paper Series 3623, The World Bank.
  3. Simeon Djankov & Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer, . "The Regulation of Entry," Working Paper 19462, Harvard University OpenScholar.
  4. Friedman, Eric & Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 2000. "Dodging the grabbing hand: the determinants of unofficial activity in 69 countries," Journal of Public Economics, Elsevier, vol. 76(3), pages 459-493, June.
  5. Aureo de Paula & Jose A Sheinkman, 2007. "The Informal Sector," Levine's Bibliography 122247000000001663, UCLA Department of Economics.
  6. Dessy, Sylvain & Pallage, Stephane, 2003. "Taxes, inequality and the size of the informal sector," Journal of Development Economics, Elsevier, vol. 70(1), pages 225-233, February.
  7. Maloney, William F., 2004. "Informality Revisited," World Development, Elsevier, vol. 32(7), pages 1159-1178, July.
  8. Loayza, Norman V., 1996. "The economics of the informal sector: a simple model and some empirical evidence from Latin America," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 45(1), pages 129-162, December.
  9. Douglas Gollin, 2002. "Getting Income Shares Right," Journal of Political Economy, University of Chicago Press, vol. 110(2), pages 458-474, April.
  10. repec:reg:rpubli:271 is not listed on IDEAS
  11. Bosch, Mariano & Maloney, William, 2005. "Labor market dynamics in developing countries: comparative analysis using continuous time Markov processes," Policy Research Working Paper Series 3583, The World Bank.
  12. Eric Friedman & Simon Johnson & Daniel Kaufmann & Pablo Zoido-Lobaton, 1999. "Dodging the Grabbing Hand: The Determinants of Unofficial Activity in 69," Departmental Working Papers 199921, Rutgers University, Department of Economics.
  13. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  14. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
  15. Fiess, Norbert M. & Fugazza, Marco & Maloney, William F., 2007. "Informal Labor Markets and Macroeconomic Fluctuations," Proceedings of the German Development Economics Conference, Göttingen 2007 6, Verein für Socialpolitik, Research Committee Development Economics.
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