A Theory of the Informal Sector

Yoshiaki Azuma and Herschel I. Grossman

No 8823, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In many countries, especially poor countries, a heavy burden of taxes, bribes, and bureaucratic hassles drives many producers into the informal sector. Is this situation explicable only as a consequence of either the ignorance or the ineptitude of the state authorities? On the contrary this paper shows that we can attribute the existence of a large informal sector to the fact that, because productive endowments contain important unobservable components, the state cannot adjust the amounts that it extracts from producers in the formal sector according to each producer's endowment. Given this fact we find that, if either the distribution of endowments is sufficiently inegalitarian or the production of private substitutes for public services is sufficiently easy, then the state would extract a large enough amount from producers in the formal sector that poorly endowed producers would choose to work in the informal sector. This result obtains both for a proprietary state, which maximizes its own net revenue, and for a hypothetical benevolent state, which would maximize the total net income of producers. But, we also find that a proprietary state would create an informal sector for a larger set of combinations of parameter values than would a hypothetical benevolent state.

JEL-codes: H0 K4 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-lam, nep-law and nep-pbe
Date: 2002-03
Note: EFG PE
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Related works:
Working Paper: A Theory of the Informal Sector (2002)
Journal Article: A THEORY OF THE INFORMAL SECTOR (2008)
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