Informal Labour and Credit Markets: A Survey.

et al. (2007) that focuses exclusively on Latin America), or one type of equilibrium (like
Ghosh et al. (1999) that focuses uniquely on partial equilibrium models of informal credit
markets).⁴ By contrast we emphasize the need for dynamic general equilibrium (DGE) and
ultimately dynamic stochastic general equilibrium (DSGE) models for a full understanding
of the costs, benefits and policy implications of informality.

The rest of the paper is organized as follows. Section 2 surveys the empirical evidence
on informality. Section 3 describes early models of informal labour markets. Section
4 introduces the three margins of informality and the standard search-matching model.
First, it discusses the intersectoral margin for workers and the traditional concerns of
wage dualism. Second, it analyzes theoretical developments on the intersectoral margin
for firms and finally presents the most recent theoretical developments on the intrafirm
margin and the occupational choice. Section 5 discusses informality in the credit sector.
Section 6 describes the move to a dynamic general equilibrium approach to informality.
Section 7 concludes with a summary of a number of open questions.

2 Literature on empirical evidence

The literature on the empirical evidence on informality takes at heart four main questions:
1) How do we measure the informal economy? 2) How large is the informal economy in
the world? 3) What are the main drivers of the informal behavior? And last but not least,
4) What impact does informality have on the formal economy? Below we summarize key
findings in these areas.⁵

2.1 How do we measure the informal economy?

How do we measure the informal economy? There are two approaches in the literature
in attempting to respond this question. The first focuses on measures of hidden income,
while the second on the size of informal employment. The size of the informal economy
can differ considerably depending on which measurement we use.

Examples of the first approach include Schneider (2005) and Chaudari et al. (2006),
⁴See Table 1 for a description of the various aspects of informality.

⁵ See Perry et al. (2007) for a detailed analysis on Latin American and Caribbean countries, Schneider
and Enste (2000) and Schneider (2005) for a more global approach.

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