Informality in the Process of Development and Growth

61 Pages Posted: 7 Jan 2017

See all articles by Norman Loayza

Norman Loayza

World Bank - Research Department

Multiple version iconThere are 2 versions of this paper

Date Written: December 2016


‘Informality’ is a term used to describe the collection of firms, workers and activities that operate outside the legal and regulatory systems. It is widespread in the majority of developing countries – in a typical developing economy, the informal sector produces about 35 per cent of GDP and employs 70 per cent of the labour force. This paper studies informality in the context of economic development by presenting a model and projections that link informality, regulations, migration and economic growth. This analytical framework highlights the trade‐offs between formality and informality, the relationship between the different types of informality, and the connection between them and the forces of labour, capital and productivity growth. The paper models the behaviour of the informal sector based on the following fundamental asymmetry: formal firms confront higher labour costs, while informal firms face higher capital costs and lower productivity. Using mandated minimum wages as the policy‐induced distortion, the model first studies the static allocation of formal and informal capital and labour in a modern economy. Second, it opens the possibility of labour migration from a rudimentary economy with ample supply of labour (e.g. rural areas or less advanced neighbouring countries). Third, the model analyses the dynamic behaviour of the formal and informal sectors, considering how they affect and are affected by economic growth and labour migration. Then, the paper presents projections for the size of labour informality, in the modern and rudimentary economies, in the next two decades for a large group of countries representing all regions of the world. The projections are based on the calibration and simulation of the model and serve to discuss its usefulness and limitations.

Suggested Citation

Loayza, Norman, Informality in the Process of Development and Growth (December 2016). The World Economy, Vol. 39, Issue 12, pp. 1856-1916, 2016. Available at SSRN: or

Norman Loayza (Contact Author)

World Bank - Research Department ( email )

1818 H Street, N.W.
Washington, DC 20433
United States

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