Formal-informal economy linkages and unemployment in South Africa

Rob Davies and James Thurlow

No 943, IFPRI discussion papers from International Food Policy Research Institute (IFPRI)

Abstract: South Africa's high involuntary unemployment and small informal sector are attributed to an underperforming formal sector and barriers to entry in the informal sector. This paper examines the economywide linkages between the formal and informal economies while accounting for different types of informal activities. A multiregion empirically calibrated general equilibrium model is developed capturing both product and labor markets. Three policy options are considered. First, results indicate that trade liberalization reduces national employment. At the same time, it increases formal employment, hurts informal producers, and favors informal traders, who benefit from lower import prices. Past liberalization may, therefore, partly explain South Africa's small informal sector and its concentration among traders rather than producers. Second, wage subsidies on low-skilled formal workers increase national employment but hurt informal producers by heightening competition in domestic product markets. This suggests that it is insufficient to examine unemployment policies by focusing only on labor markets. Third, unconditional cash transfers stimulate demand for informally produced products, thereby raising informal employment without undermining formal producers. The transfer does, however, place a large fiscal burden on the state and is less effective at reducing national unemployment than a wage subsidy. Overall, these findings underline the importance of distinguishing between the formal and informal sector implications of socioeconomic policies.

Keywords: informal economy; involuntary unemployment; formal economy; labor markets; trade liberalization; national employment; Cash transfers; wage subsidy; Computable general equilibrium (CGE) modeling; Development strategies (search for similar items in EconPapers)
Date: 2009
New Economics Papers: this item is included in nep-afr, nep-cmp, nep-dev and nep-lab
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Journal Article: FORMAL–INFORMAL ECONOMY LINKAGES AND UNEMPLOYMENT IN SOUTH AFRICA (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:fpr:ifprid:943

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