Official Regulations and the Shadow Economy: A Labour Market Approach

Maxim Bouev

No 524, William Davidson Institute Working Papers Series from William Davidson Institute at the University of Michigan

Abstract: This work revisits the role of regulations in emergence o f the shadow economy. In particular, it supplements the previous theoretical research that mainly ignored the fact that the decision to “go underground” is essentially a result of both employers and employees interacting in the labour market. We adapt a job search approach (see, e.g. Acemoglu 2001) to model a transitional economy with an informal sector. We apply and develop the idea first documented inter alia by Loayaza (1996) that there are two types of regulations that influence the size of the informal labour market through two different channels. Red tape and bureaucratic extortion (bribing) make starting a new business officially a not very attractive option and can lead new firms to the informal sector. On the other hand, taxes and redundancy pay make official firms offer lower wages which drives potential employees away into underground jobs. Depending on various combinations of policy parameters equilibria with different share of the informal economy are possible. The paper draws conclusions regarding the role of unemployment benefits in reducing the size of the informal economy. Policy implications are offered.

Keywords: informal economy; labour markets; corruption; regulations; search models (search for similar items in EconPapers)
JEL-codes: H26 J41 J42 J64 O17 (search for similar items in EconPapers)
Pages: 39 pages
Date: 2002-12-01
New Economics Papers: this item is included in nep-dev, nep-pbe and nep-tra
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

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