Informal Labour and Credit Markets: A Survey.



in favor of, both, the segmented and the voluntary view of the informal sector depending
on the origin of the shock and the presence of wage rigidities in the formal labour market.

6.3 Endogenous growth and informality

The growth literature has made much progress in identifying the determinants of economic
growth since mid 1980s and recently started explaining why growth rates vary across
countries. As discussed in a special lecture by Hsieh (2009), potential determinants of such
variation include misallocation of inputs across firms and industries as well as informality
and, nevertheless, the growth literature has paid little attention to the relationship between
growth and informality.

A few endogenous growth models with the presence of the informal sector are reviewed
here, such as Loayza (1997), Sarte (1997) and Dasgupta (2005). As in the present survey,
Loayza (1997) discusses the rationality of being informal in the light of the costs and
benefits of legality of businesses and recognizes the importance of government-provided
goods and services as they are part of costs of informality and congested by informal
production. Loayza (1997) develops an AK-type endogenous model that exhibits constant
returns to capital Rebelo (1991) in which the assumption of Barro and Sala-i Martin
(1992) is incorporated that the relative amount of public services to aggregate production
available to individual agents determines the capital rate of returns. In this framework,
agents in the formal sector pay a proportional fraction of income as taxes while agents in
the informal sector pay a proportional fraction of income as penalties for being illegal and
thus they have a limited access to available public services. Agents are assumed to freely
move across sectors. Public services are assumed to be financed by taxes on production of
the formal sector and to be positively affected by the quality of government institutions.
To reflect congestible public services, the relative size of the informal sector is devised
to reduce capital productive for all agents in the economy. Within this framework, the
equilibrium is to be set where formal and informal rates of returns equate. The model
predicts that the relative size of the informal sector has a negative impact on economic
growth particularly in economies with high tax burden and week enforcement systems that
in general increase the size of the informal sector.

Another study that follows similar arguments in an endogenous growth framework is

30



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