Informality and Long-Run Growth

42 Pages Posted: 18 Jan 2014

See all articles by Frédéric Docquier

Frédéric Docquier

Université catholique de Louvain; CREAM, Centre for Research on Environmental Appraisal & Management, UK; IZA Institute of Labor Economics

Tobias Müller

University of Geneva - Geneva School of Economics and Management

Joaquín Naval

University of Girona - Department of Economics

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Abstract

One of the most salient features of developing economies is the existence of a large informal sector. This paper uses quantitative theory to study the dynamic implications of informality on wage inequality, human capital accumulation, child labor and long-run growth. Our model can generate transitory informality equilibria or informality-induced poverty traps. Its calibration reveals that the case for the poverty-trap hypothesis is strong: although informality serves to protect low-skilled workers from extreme poverty in the short-run, it prevents income convergence between developed and developing nations in the long run. Sudden elimination of informality would induce severe welfare losses for several generations on the transition path. Hence, we examine the effectiveness of different development policies to exit the poverty trap. Our numerical experiments show that using means-tested education subsidies is the most cost-effective single policy option. However, for longer time horizons, or as the economy gets closer to the poverty trap threshold, combining means-tested education and wage subsidies is even more effective.

Keywords: informality, development, education, child labor, inequality

JEL Classification: O11, O15, O17

Suggested Citation

Docquier, Frédéric and Müller, Tobias and Naval, Joaquín, Informality and Long-Run Growth. IZA Discussion Paper No. 7883. Available at SSRN: https://ssrn.com/abstract=2381135

Frédéric Docquier (Contact Author)

Université catholique de Louvain ( email )

IRES
Place Montesquieu 3
Louvain-la-Neuve, 1348
Belgium

HOME PAGE: http://https://perso.uclouvain.be/frederic.docquier/

CREAM, Centre for Research on Environmental Appraisal & Management, UK

University of Newcastle
NE1 7RU Newcastle Upon Tyne
United States

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Tobias Müller

University of Geneva - Geneva School of Economics and Management ( email )

40, boulevard du Pont-d'Arve
Geneva 4, CH-1211
Switzerland
+41 22 379 8238 (Phone)

Joaquín Naval

University of Girona - Department of Economics ( email )

Campus de Montilivi
Girona, Girona 17071
Spain

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