Trade and Domestic Distortions: The Case of Informality

114 Pages Posted: 27 Jan 2021 Last revised: 27 Jan 2025

See all articles by Rafael Dix-Carneiro

Rafael Dix-Carneiro

Duke University

Pinelopi Goldberg

Yale University - Department of Economics; National Bureau of Economic Research (NBER); Yale University - Cowles Foundation; Peterson Institute for International Economics; Bureau for Research and Economic Analysis of Development (BREAD); Centre for Economic Policy Research (CEPR)

Costas Meghir

Yale University; Yale University - Cowles Foundation; Institute for Fiscal Studies (IFS); National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Gabriel Ulyssea

University of Oxford - Department of Economics

Multiple version iconThere are 4 versions of this paper

Date Written: January 2021

Abstract

We examine the effects of international trade in the presence of a set of domestic distortions giving rise to informality, a prevalent phenomenon in developing countries. In our quantitative model, the informal sector arises from burdensome taxes and regulations that are imperfectly enforced by the government. Consequently, smaller, less productive firms face fewer distortions than larger, more productive ones, potentially leading to substantial misallocation. We show that in settings with a large informal sector, the gains from trade are significantly amplified, as reductions in trade barriers imply a reallocation of resources from initially less distorted to more distorted firms. We confirm findings from earlier reduced-form studies that the informal sector mitigates the impact of negative labor demand shocks on unemployment. Nonetheless, the informal sector can exacerbate the adverse welfare effects of economic downturns, amplifying misallocation. Last, our research sheds light on the relationship between trade openness and cross-firm wage inequality.

Suggested Citation

Dix-Carneiro, Rafael and Goldberg, Pinelopi (Penny) and Meghir, Costas and Ulyssea, Gabriel, Trade and Domestic Distortions: The Case of Informality (January 2021). NBER Working Paper No. w28391, Available at SSRN: https://ssrn.com/abstract=3772638

Rafael Dix-Carneiro (Contact Author)

Duke University ( email )

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Pinelopi (Penny) Goldberg

Yale University - Department of Economics ( email )

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Yale University - Cowles Foundation

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Bureau for Research and Economic Analysis of Development (BREAD) ( email )

Duke University
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Centre for Economic Policy Research (CEPR) ( email )

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Costas Meghir

Yale University ( email )

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Yale University - Cowles Foundation ( email )

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National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR)

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IZA Institute of Labor Economics

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Gabriel Ulyssea

University of Oxford - Department of Economics ( email )

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