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GTAP Resource #1530

"Economic Reforms, Governance and the Informal Sector"
by Marjit, Sugata and Dr. Amit Kumar Biswas

Economic reform or liberal economic policies have been taking firm root in the entire developing world. Be it Latin America, Asia or Africa tariffs are being reduced, foreign investment is being encouraged and interventionist strategies are slowly taking a backseat. Naturally volumes are being contributed towards justifying or criticizing market-based reformist policies. A key feature of the developing world is that most of its work force is absorbed in the informal sectors, sectors which are usually not registered, non-tax paying and most likely to ignore labour laws or unionized wage negotiations. Agenor (1987) gives a detailed list of the relevant work on several developing countries which repeatedly assert the significance of informal labour market. Therefore, it is natural to ask how reforms are going to affect the informal segment of the labour market.
We think that two issues should be of prime importance in the current context. First, the reforms are likely to affect wage and employment in the informal sector. There have been some attempts to explore these issues. Kar and Marjit (2001) and Marjit (2003) have tried to analyse the impact of trade reforms on informal wage in terms of general equilibrium models. These models build on the assumption of a dual labour market with fixed as well as flexible wage contracts and labour mobility. In a way this is also related to Bulow and Summers (1986), Carruth and Oswald (1981), Saint-Paul (1996), Agenor and Montiel (1996) etc. Marjit, Kar and Sarkar (2003) substantiates earlier theoretical claims with evidence drawn from informal manufacturing in India. In these papers reform tends to expand size of the informal sector through a cut back in employment in the formal sector when formal and informal are producing different goods and a tariff protects the formal sector. Apparently, if one focuses on a typical import competing sector, which has both formal and informal segments, the impact of a reform is less clear. For example, a negative output effect of a tariff cut should be felt by both segments and one does not know a priori how the composition will change. In a recent paper Goldberg and Pavcnik (2003) provides a detailed empirical evidence on Brazil and Colombia to highlight the impact of trade reform on the size of the informal sector. While Colombia clearly demonstrates an expansion in the informal segment, Brazil demonstrates very little change. With this backdrop in place, our purpose is to understand
the relationship between the size of informal production and reformatory policies by treating the case of an import-competing sector.
Another important departure from the exiting literature is in raising the issue of governance. Use of informal workers is illegal in our set up since this involves violation of labour laws. We argue that if the producer is monitored and apprehended for operating an ‘informal’ segment, he faces a penalty. However, he can get away by paying a bribe to the apprehending agent. It is reasonable to argue that the opportunity costs of such actions are monotonic in benefits from protection. We develop an explicit Nash-bargaining structure to determine the equilibrium bribe. This outcome is internalized by the firm while deciding the allocation of production or employment between the formal and informal sector.
Although our focus is on trade related reform, i.e., a decline in the tariff rate, we also consider the case where return to capital or cost of capital is reduced. This is also a worldwide phenomenon and real interest rate has drastically come down in the developing world.

Resource Details (Export Citation) GTAP Keywords
Category: 2004 Conference Paper
Status: Published
By/In: Presented at the 7th Annual Conference on Global Economic Analysis, Washington DC, USA
Date: 2004
Created: Biswas, D. (5/5/2004)
Updated: Bacou, M. (6/4/2004)
Visits: 2,461
- Domestic policy analysis

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