nep-iue New Economics Papers
on Informal and Underground Economics
Issue of 2011‒08‒02
five papers chosen by
Catalina Granda Carvajal
Universidad de Antioquia

  1. Contractual Dualism, Market Power and Informality By Basu, Arnab K.; Chau, Nancy; Kanbur, Ravi
  2. Formal sector price discoveries: preliminary results from a developing country By Choudhary, M. Ali; Naeem, Saima; Faheem, Abdul; Hanif, Nadim; Pasha, Farooq
  3. Developing new measurements of State institutional capacity By Popov, Vladimir
  4. The Value of Honesty: Empirical Estimates from the Case of the Missing Children By Sara LaLumia; James M. Sallee
  5. Who are the outsiders and what do they want? Welfare state preferences in dualized societies By Silja Häusermann, Hanna Schwander

  1. By: Basu, Arnab K. (College of William and Mary); Chau, Nancy (Cornell University); Kanbur, Ravi (Cornell University)
    Abstract: Two stylized representations are often found in the academic and policy literature on informality and formality in developing countries. The first is that the informal (or unregulated) sector is more competitive than the formal (or regulated) sector. The second is that contract enforcement is easier in the formal sector than in the informal sector, precisely because the formal sector comes under the purview of state regulation. The basic contention of this paper is that these two representations are not compatible with each other. We develop a search-theoretic model of contractual dualism in the labor market where the inability to commit to contracts in the informal sector leads to employer market power in equilibrium, while an enforced minimum wage in the formal sector provides employers with a commitment technology but which reduces their market power in equilibrium. The contributions of this paper are three-fold. It (i) provides the micro-underpinnings for endogenous determination of employer market power in the formal and informal sectors due to contractual dualism in the two sectors, (ii) offers a unified and coherent setup whereby a host of salient features of developing country labor markets can be explained together, and (iii) places the original Stiglerian prescription of the optimal (unemployment minimizing) minimum wage in the broader context of labor markets where formal job creation is costly, and where formal employment, informal employment, and unemployment co-exist.
    Keywords: contractual dualism, wage dualism, employer market power, informality
    JEL: J3 J6 O17
    Date: 2011–07
  2. By: Choudhary, M. Ali; Naeem, Saima; Faheem, Abdul; Hanif, Nadim; Pasha, Farooq
    Abstract: We present preliminary results of 1086 structured interviews about price setting behavior of the formal firms in the manufacturing and services sector of Pakistan. Our key discoveries are that frequency of price change is considerably high in Pakistan, lowering the real impact of monetary policy. Price rigidity is explained mainly by firms caring about relative prices and the persistence of a given shock. The exchange rate and cost shocks are more important than financial and demand shocks for both setting prices and also the readiness with which these pass-through to the economy. Large firms change prices more frequently compared to smaller firms. Formal sector firms, especially medium sized firms, interact more with informal sector firms through the demand and supply channels. Formal firms highly connected with the informal sector have lower frequency of price changes. Formal sector firms hold lack of taxes and compliance with tax regime, i.e. enforcement, as the main reasons for the existence of the informal sector.
    Keywords: Price Setting; Developing Country
    JEL: D21 L11 E31
    Date: 2011–07–18
  3. By: Popov, Vladimir
    Abstract: According to a narrow definition, institutional capacity of the state is the ability of the government to enforce laws and regulations. There are a lot of subjective indices (control over corruption, rule of law, government effectiveness, etc.) that are designed to measure the state institutional capacity and are based on experts’ estimates. The logical objective measures of the state institutional capacity are the murder rate – non-compliance with the state’s monopoly on violence, and the shadow economy – non compliance with the economic regulations. It appears that political regime (democratic or authoritarian) matters for the subjective ranking. It could be shown, for instance, that out of two countries with the same murder rate, government effectiveness is higher in countries that were more democratic in the past (1970s-1990s on average) and in the year (2002) when government effectiveness was measured. This result holds for all other five World Bank subjective indices of institutional capacity – rule of law, control over corruption, voice and accountability, political stability and regulation quality. And they hold also for the share of shadow economy: out of two countries with the same share of shadow economy, government effectiveness is higher in a more democratic one.
    Keywords: Institutional capacity; murder rate; shadow economy; democratization
    JEL: O17 K42
    Date: 2011–03
  4. By: Sara LaLumia; James M. Sallee
    Abstract: How much are people willing to forego to be honest, to follow the rules? When people do break the rules, what can standard data sources tell us about their behavior? Standard economic models of crime typically assume that individuals are indifferent to dishonesty, so that they will cheat or lie as long as the expected pecuniary benefits exceed the expected costs of being caught and punished. We investigate this presumption by studying the response to a change in tax reporting rules that made it much more difficult for taxpayers to evade taxes by inappropriately claiming additional dependents. The policy reform induced a substantial reduction in the number of dependents claimed, which indicates that many filers had been cheating before the reform. Yet, the number of filers who availed themselves of this evasion opportunity is dwarfed by the number of filers who passed up substantial tax savings by not claiming extra dependents. By declining the opportunity to cheat, these taxpayers reveal information about their willingness to pay to be honest. We present a novel method for inferring the characteristics of taxpayers in the absence of audit data. Our analysis suggests both that this willingness to pay to be honest is large on average and that it varies significantly across the population of taxpayers.
    JEL: H24 H26
    Date: 2011–07
  5. By: Silja Häusermann, Hanna Schwander
    Abstract: This paper makes three contributions. First, it presents a new conceptualization and measurement of outsider-status, which is based on social class and which takes into account that the category of outsiders is composed differently in different countries, depending on labor markets and welfare states. Second, it argues theoretically and shows empirically that the class-based measure of insider-and outsider status has a stronger explanatory power with regard to individual-level welfare preferences than the measure based on labor market status. And third, it demonstrates empirically that dualization, combined with skill-levels, shapes people’s preferences with regard to different welfare policies: Outsiders have stronger preferences for redistribution and for social investment than insiders. The analyses are based on micro-level ISSP data.
    Keywords: labour contract; political economy; social policy; unemployment; welfare state
    Date: 2011–07–21

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