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Environmental Regulation in the Presence of an Informal Sector


  • Soham Baksi
  • Pinaki Bose


We analyze the efficacy of environmental regulation in the presence of an endogenous informal sector. Firms in an imperfectly competitive formal sector produce a final good using a polluting intermediate good. The firms can either produce the intermediate good or purchase it from a price-taking informal sector. An environmental regulator sets the emission intensity of the intermediate good that all formal sector firms implement honestly but informal sector firms seek, and are sometimes able, to evade. We show that, depending on the stringency of the regulation and its enforcement, the informal sector can act as a source of pollution leakage. Stricter regulation can increase (when the “composition effect” of regulation dominates its “scale effect”) or decrease total pollution, and may even have a non-monotonic impact. Further, price discrimination by the formal sector, when it purchases the intermediate good from the informal sector, can worsen regulatory compliance by the informal sector and lead to lower welfare.

Suggested Citation

  • Soham Baksi & Pinaki Bose, 2010. "Environmental Regulation in the Presence of an Informal Sector," Departmental Working Papers 2010-03, The University of Winnipeg, Department of Economics.
  • Handle: RePEc:win:winwop:2010-03

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    References listed on IDEAS

    1. Chaudhuri, Tamal Datta, 1989. "A theoretical analysis of the informal sector," World Development, Elsevier, vol. 17(3), pages 351-355, March.
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    Cited by:

    1. Ummad Mazhar & Ceyhun Elgin, 2013. "Environmental Regulation, Pollution and the Informal Economy," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 9, pages 62-81.
    2. Gökçer Özgür & Ceyhun Elgin & Adem Y. Elveren, 2021. "Is informality a barrier to sustainable development?," Sustainable Development, John Wiley & Sons, Ltd., vol. 29(1), pages 45-65, January.
    3. Elgin, Ceyhun & Oztunali, Oguz, 2014. "Pollution and informal economy," Economic Systems, Elsevier, vol. 38(3), pages 333-349.
    4. Goel, Rajeev K. & Saunoris, James W., 2020. "Spatial spillovers of pollution onto the underground sector," Energy Policy, Elsevier, vol. 144(C).
    5. Cong Minh Huynh, 2020. "Shadow economy and air pollution in developing Asia: what is the role of fiscal policy?," Environmental Economics and Policy Studies, Springer;Society for Environmental Economics and Policy Studies - SEEPS, vol. 22(3), pages 357-381, July.
    6. Wunhong Su & Chun Guo & Xiaobao Song, 2022. "Media coverage, Environment Protection Law and environmental research and development: evidence from the Chinese-listed firms," Environment, Development and Sustainability: A Multidisciplinary Approach to the Theory and Practice of Sustainable Development, Springer, vol. 24(5), pages 6953-6983, May.
    7. Hilaire Nkengfack & Hervé Kaffo Fotio & Armand Totouom, 2021. "How Does the Shadow Economy Affect Environmental Quality in Sub-Saharan Africa? Evidence from Heterogeneous Panel Estimations," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 12(4), pages 1635-1651, December.
    8. Mehdi Abid, 2019. "Estimating the Size of the Informal Trade Across the World: Evidence from a MIMIC Approach," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 10(2), pages 618-669, June.
    9. Alvarado, Rafael & Tillaguango, Brayan & Murshed, Muntasir & Ochoa-Moreno, Santiago & Rehman, Abdul & Işık, Cem & Alvarado-Espejo, Johana, 2022. "Impact of the informal economy on the ecological footprint: The role of urban concentration and globalization," Economic Analysis and Policy, Elsevier, vol. 75(C), pages 750-767.
    10. Nguyen, Canh Phuc & Nguyen, Binh Quang, 2023. "Environmental foe or friend: The influence of the shadow economy on forest land," Land Use Policy, Elsevier, vol. 124(C).
    11. Biswas, Amit K. & Farzanegan, Mohammad Reza & Thum, Marcel, 2012. "Pollution, shadow economy and corruption: Theory and evidence," Ecological Economics, Elsevier, vol. 75(C), pages 114-125.
    12. Mehdi Abid, 2016. "Size and Implication of Informal Economy in African Countries: Evidence from a Structural Model," International Economic Journal, Taylor & Francis Journals, vol. 30(4), pages 571-598, October.
    13. Jinhua Shao & Brayan Tillaguango & Rafael Alvarado & Santiago Ochoa-Moreno & Johanna Alvarado-Espejo, 2021. "Environmental Impact of the Shadow Economy, Globalisation, Trade and Market Size: Evidence Using Linear and Non-Linear Methods," Sustainability, MDPI, vol. 13(12), pages 1-20, June.
    14. Canh, Nguyen Phuc & Schinckus, Christophe & Thanh, Su Dinh & Chong, Felicia Hui Ling, 2021. "The determinants of the energy consumption: A shadow economy-based perspective," Energy, Elsevier, vol. 225(C).
    15. Shi Wang & Yizhou Yuan & Hua Wang, 2019. "Corruption, Hidden Economy and Environmental Pollution: A Spatial Econometric Analysis Based on China’s Provincial Panel Data," IJERPH, MDPI, vol. 16(16), pages 1-23, August.
    16. Burgi,Constantin Rudolf Salomo & Hovhannisyan,Shoghik & Joshi,Santosh Ram & Ahmad Famm Alkhuzam, 2022. "Informal Emissions," Policy Research Working Paper Series 10158, The World Bank.
    17. Ceyhun Elgin & Oğuz Öztunalı, 2014. "Environmental Kuznets Curve for the Informal Sector of Turkey (1950-2009)," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 61(4), pages 471-485, September.
    18. Pang, Jingru & Li, Nan & Mu, Hailin & Jin, Xin & Zhang, Ming, 2022. "Asymmetric effects of urbanization on shadow economy both in short-run and long-run:New evidence from dynamic panel threshold model," Technological Forecasting and Social Change, Elsevier, vol. 177(C).
    19. GOMADO, Kwamivi Mawuli, 2018. "Diversité ethnique et déforestation dans les pays en développement: identification des principaux canaux [Ethnic diversity and deforestation in developing countries: identifying the transmission ch," MPRA Paper 89380, University Library of Munich, Germany.
    20. Sudeshna Chattopadhyay & Sarmila Banerjee & Katrin Millock, 2010. "Pollution Control Instruments in the Presence of an Informal Sector," Post-Print halshs-00560558, HAL.
    21. Goel, Rajeev K. & Herrala, Risto & Mazhar, Ummad, 2013. "Institutional quality and environmental pollution: MENA countries versus the rest of the world," Economic Systems, Elsevier, vol. 37(4), pages 508-521.
    22. Zhimin Zhou, 2019. "The Underground Economy and Carbon Dioxide (CO 2 ) Emissions in China," Sustainability, MDPI, vol. 11(10), pages 1-20, May.
    23. Nguyen Phuc Canh & Su Dinh Thanh & Christophe Schinckus & Jo Bensemann & Lai Trung Thanh, 2019. "Global Emissions: A New Contribution from the Shadow Economy," International Journal of Energy Economics and Policy, Econjournals, vol. 9(3), pages 320-337.
    24. Hbib Sekrafi & Asma Sghaier, 2018. "Examining the Relationship Between Corruption, Economic Growth, Environmental Degradation, and Energy Consumption: a Panel Analysis in MENA Region," Journal of the Knowledge Economy, Springer;Portland International Center for Management of Engineering and Technology (PICMET), vol. 9(3), pages 963-979, September.

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    More about this item

    JEL classification:

    • Q56 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law

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