Informal Labour and Credit Markets: A Survey.

do not find a job they work in the informal sector (i.e. unemployed as informal workers
as in Saatchi and Temple).²⁶ “It may be argued that the problem of the very poor and
the unskilled was never lack of jobs, but the wage rate”. According to this, it is the
wage rate and not the employment status a criterion to measure the standard of living in
the developing world (Marjit and Kar (2008)). Ihrig and Moe (2004) develop a dynamic
general equilibrium model with 2 sectors: a formal sector where firms employ labour and
capital and an informal sector with firms employing only labour (i.e. there is a fixed stock
of capital). The economic agents decide between consumption and savings and the time
allocated to the two sectors. As capital increases in the formal sector labour moves from
the informal to the formal sector until the marginal productivities of labour in the two
sectors are equalized. The main trade-off is between paying taxes to the government or
access to formal capital markets.

Conesa et al. (2002) present a similar model, but introduce a stochastic element. To
the best of our knowledge, this is the first DSGE model that incorporates an informal
sector. The authors introduce a second sector into a standard Real Business Cycle (RBC)
model which is described as an “underground” economy that has a different technology,
produces goods and services that could otherwise be produced in the formal sector, but
is not registered in NI accounts. As pointed out by the authors, ...“The tradability of the
output generated by this activities is the key features distinguishing our approach from the
household production literature. The main characteristics of the model include: a wage
premium which can be seen as the opportunity cost of not working in the official sector
and labour indivisibilities in the formal/registered sector. Households choose a probability
of working in the informal sector which can be interpreted as the purchase of lotteries in a
perfectly insured market. When a worker chooses the informal sector he/she enjoy more
leisure at the price of a smaller wage, while in the formal sector individuals work more,
but receive a wage premium. In particular, the authors assume labour to be indivisible in
the formal/registered sector with hours worked fixed exogenously.

The main prediction of the model is that wage premium differentials can explain the
different size of macroeconomic fluctuations as a function of technological shocks. The
intuition is the following: countries with a smaller wage premium have a lower opportunity
²⁶ Satchi and Temple (2009) develop this idea in a search-matching model and for this reason the paper
is discussed in section 4.

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