Informality: Causes and Consequences for Development

Abstract

This article reviews the economic literature on informality, its causes, and its consequences for development. It covers a comprehensive body of research that ranges from well-identified experimental studies to equilibrium macro models, and which more recently includes structural models that integrate both micro and macro effects. The results available in the literature indicate that lowering the costs of formality is not an effective policy to reduce informality but may generate positive aggregate effects, such as higher output and total factor productivity (TFP). The most effective formalization policy is to increase enforcement on the extensive margin but not on the intensive margin of informality. The former generates substantial gains in aggregate TFP and output, without necessarily increasing unemployment. However, the overall welfare impacts are likely to depend on the transitional dynamics between steady states, which remains an open area for future research. Expected final online publication date for the Annual Review of Economics, Volume 12 is August 3, 2020. Please see http://www.annualreviews.org/page/journal/pubdates for revised estimates.

Blame it on the Rain: The Effects of Weather Shocks on Formal Rural Employment in Colombia

“…This paper aims to contribute to the literature on adaptation to climate change (Kochar, 1999;Mueller and Osgood, 2009;Dillon, Mueller, and Salau, 2011;Loayza et al, 2012;Jessoe, Manning, and Taylor, 2018;Quinones, 2018;Brey and Hertweck, 2019;Burzyński et al, 2019;Maitra and Tagat, 2019) as we study how one of the mitigation mechanisms available to producers, such as quantity of employment hired, responds to unexpected productivity shocks due to changes in rain patterns. This paper also adds to the existing literature on informality and labor market regulation in developing countries as in Almeida and Carneiro (2012), Meghir, Narita, and Robin (2015), Ulyssea and Ponczek (2018), and Ulyssea (2020). Another relevant feature of this study, as displayed by the regression estimates, points out that episodes of excessive rainfall do not necessarily correspond to positive shocks on agricultural production, as the literature for India or Southeast Asia has already found (Jayachandran, 2006).…”

Informality, Consumption Taxes and Redistribution

“…This leads to a more nuanced perspective on the welfare effects of informality. In particular, our findings caution that enforcement policies that reduce informality, which are often found to yield efficiency gains (Ulyssea, 2020), may also have distributional costs by increasing the burden of taxation on poorer households. Third, our classification of retailers as formal or informal overlaps with the 'traditional' versus 'modern' retail categories studied in the macro-development literature (Lagakos, 2016).…”

Informality, Consumption Taxes and Redistribution

“…This leads to a more nuanced perspective on the welfare effects of informality. In particular, our findings caution that enforcement policies to reduce informality, which are often found to yield efficiency gains (Ulyssea, 2020), may also have distributional costs by increasing the burden of taxation on poorer households. Third, our classification of retailers as formal or informal overlaps with the 'traditional' versus 'modern' retail categories studied in the macro-development literature (Lagakos, 2016).…”

“…Finally, our paper contributes to the literature on the informal sector. Existing papers focus on the 'supply side' of informality, by evaluating incentives to become formal either at the firm-level (DeSoto, 1989;De Paula and Scheinkman, 2010;La Porta and Shleifer, 2014), the worker-level (Gerard and Gonzaga, 2016;Jensen, 2019), or both (Ulyssea, 2018). Our approach complements these studies by considering the 'demand side' of informality: consumers' use of formal or informal retailers.…”