Informality in developing economies: Regulation and fiscal policies

Olivier Charlot, Franck Malherbet and Cristina Terra

Journal of Economic Dynamics and Control, 2015, vol. 51, issue C, 1-27

Abstract: This paper proposes a unified theoretical framework where formal and informal firms coexist and face the same type of product and labor market imperfections: they have monopoly power in the goods market, they are subject to matching frictions in the labor market, and wages are determined by bargaining between large firms and their workers, through either individual or collective bargaining. Our model matches the main stylized facts on informality for developing countries and appears to be a good candidate for policy analysis. In this framework, we study the impact on informality, wages and unemployment of policies that may be used to reduce informality. We consider changes in product market regulation (PMR) and in two types of fiscal policies, labor taxes and formality enforcement. We find that lessening PMR decreases informality and unemployment simultaneously, indicating that there is not necessarily a tradeoff between informality and unemployment. The tradeoff appears when fiscal policies are used, though. Moreover, the impacts of PMR on unemployment and on wages are larger under collective than individual bargaining. With respect to wage inequality, lessening PMR reduces it, while lower taxes tend to increase the formal sector wage premium.

Keywords: Informality; Product and labor market imperfections; Search and matching (search for similar items in EconPapers)
JEL-codes: E24 E26 J60 L16 O1 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (31)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:51:y:2015:i:c:p:1-27

DOI: 10.1016/j.jedc.2014.09.031

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