Informal Labour and Credit Markets: A Survey.



2.3 Causes and impact of informality

What is the impact of informality on the formal economy? Loayza (1996) tests for Latin
American countries in the 1990s predictions from his theoretical model: Countries with
large tax burden and weak enforcement system should show a negative relationship be-
tween the size of the informal sector and economic growth.
12 Results are confirmed with
countries with very restrictive labour market regulations and poor enforcement systems
showing the largest informal sector (i.e. Bolivia, Panama and Peru). Loayza (1996) also
finds a negative relationship between the size of the informal sector and real GDP growth.
In general, the relationship between informality and growth can be viewed in two of the
following ways. Following Loayza (1996), the informal sector restrains growth because it
reduces labour market productivity and hinders the enjoyment of public goods on the side
of both workers and producers. An alternative hypothesis is that, in a world with various
kind of imperfections (i.e. labour market regulation, corruption, etc.), the informal sector
increases efficiency and so it has a positive impact on economic growth. Nikopour
et al.
(2008) reviews several papers investigating empirically the relationship between informal-
ity and growth for 21 OECD countries and concludes in favor of a positive impact of
informality on growth.

Rei and Battacharya (2008) use regression analysis on low and middle-income coun-
tries’ data to establish possible drivers of informality. Using Schneider (2005) data they
find no general evidence on the impact of higher taxation and labour market regulation,
but these results are not robust to the inclusion of indices of public and corporate gover-
nance. The main finding then is that strong or stronger governance favors formality.

2.4 Main stylized facts

2.4.1 Informal employment

Looking at the empirical literature discussed above, the following stylized facts emerge:

developing countries tend to have a higher degree of informality than OECD coun-
tries (stylized fact 1, hereafter SF 1)

12The key assumption is that production technology depends on congestible public services and the
informal sector has only a limited access to this services. See section 6.2 for a more detailed analysis of
the theoretical model.



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