Informal Labour and Credit Markets: A Survey.

key public goods (property rights and contract enforceability) interact with the entry costs
in the formal sector. The model is based on two of the above mentioned costs due to the
lack of information: creation of the right incentives and “Mafia-style” enforcement. The
author builds on the investment model with moral hazard by Holmstrom-Tirole (1997)to
show that the choice between formal and informal sectors depends on the registering costs,
the relative efficiency of credit markets, initial wealth and collateral.

Along these lines, de Paula and Scheinkman (2007) explore what are the implications
of having (or not) access to formal credit markets. The authors model informality in an
occupational choice model where low ability agents work as salaried workers or become
managers in the informal sector while high ability individuals prefer to be managers in
the formal sector. The definition of informality is in terms of tax avoidance (evasion
dualism). In equilibrium, the marginal firm is indifferent between the obligation of paying
taxes on the one hand and the higher cost of capital together with scale limitations on
the other. In particular, informal firms face a higher cost of capital and a probability
equal to one to be detected if their capital is above a threshold value. Capital here is
a proxy for the size of the firm. Other authors before show that the size of the firm is
an important factor in the distinction between formal and informal firms, Rauch (1991)
de Paula and Scheinkman (2007) add capital and show that constrained and unconstrained
informal firms have a lower capital-labour ratio than formal firms. They then develop a
model with two production stages and show that the informality of a firm is correlated
to the informality of its upstream and downstream sector. Also based on Rauch (1991),
Antunes and Cavalcanti (2007) model the firm’s decision to be formal or informal. In
particular, risk-neutral agents decide to be workers or entrepreneurs in function of their
talents. Entrepreneurs then decide to be formal or informal through a cost-benefit analysis
in which they weight the possibility to avoid taxes and regulation costs with the imperfect
access to formal credit markets.

5.4 Informal credit markets and monetary policy

The implications for monetary policy of informal behavior in credit markets are contro-
versial. One set of scholars examining this in the context o low income countries, for
example, argues that low interest rate policy would reduce the cost of physical capital and

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