nep-iue New Economics Papers
on Informal and Underground Economics
Issue of 2012‒11‒17
twelve papers chosen by
Catalina Granda Carvajal
Universidad de Antioquia

  1. Wages and Informality in Developing Countries By Meghir, Costas; Narita, Renata; Robin, Jean-Marc
  2. Labor Mobility Across The Formal/Informal Divide in Turkey: Evidence From Individual Level Data By Aysit Tansel; Elif Oznur Kan
  3. The Formal/Informal Employment Earnings Gap: Evidence From Turkey By Aysit Tansel; Elif Oznur Kan
  4. Informality and overeducation in the labor market of a developing country By Paula Herrera-Idárraga; Enrique López-Bazo; Elisabet Motellón
  5. Monetary policy, informality and business cycle fluctuations in a developing economy vulnerable to external shocks By Haider, Adnan; Din, Musleh-ud; Ghani, Ejaz
  6. Does Trust Matter For Entrepreuneurship : Evidence From A Cross-Section Of Countries By Kodila-Tedika, Oasis; Agbor Agbor, Julius
  7. Keeping both Corruption and the Shadow Economy in Check: The Role of Decentralization. By Roberto Dell'Anno; Désirée Teobaldelli
  8. Citizenship and Power in an Agent-based Model of Tax Compliance with Public Expenditure By Paolo Pellizzari; Dino Rizzi
  9. Estimating the Federal Direct Tax Buoyancy for Pakistan in Post-1973 Era By Shaikh, Salman
  10. The Relation between Equity Incentives and Misreporting: The Role of Risk-Taking Incentives By Armstrong, Christopher S.; Larcker, David F.; Ormazabal, Gaizka; Taylor, Daniel J.
  11. Labor Surplus Revisited By Ranis, Gustav
  12. Loan Regulation and Child Labor in Rural India By Dasgupta, Basab; Zimmermann, Christian

  1. By: Meghir, Costas (Yale University and IFS, London); Narita, Renata (World Bank); Robin, Jean-Marc (Sciences Po, Paris and U College London)
    Abstract: It is often argued that informal labor markets in developing countries promote growth by reducing the impact of regulation. On the other hand informality may reduce the amount of social protection offered to workers. We extend the wage-posting framework of Burdett and Mortensen (1998) to allow heterogeneous firms to decide whether to locate in the formal or the informal sector, as well as set wages. Workers engage in both off the job and on the job search. We estimate the model using Brazilian micro data and evaluate the labor market and welfare effects of policies towards informality.
    JEL: J24 J30 J42 J60 O17
    Date: 2012–09
  2. By: Aysit Tansel (Department of Economics, METU); Elif Oznur Kan (Department of International Trade, Cankaya University)
    Abstract: Informality has long been a salient phenomenon in developing country labor markets, thus has been addressed in several theoretical and empirical research. Turkey, given its economic and demographic dynamics, provides rich evidence for a growing, heterogeneous and multifaceted informal labor market. However, the existing evidence on labor informality in Turkey is mixed and scant. Along these lines, we aim to extend the existing literature by providing a diagnosis of dynamic worker flows across distinct labor market states and identifying the effects of certain individual and job characteristics on variant mobility patterns. More specifically, we first develop and discuss a set of probability statistics based on annual worker transitions across distinct employment states utilizing Markov transition processes. As Bosch and Maloney (2007:3) argue: “labor status mobility can be assumed as a process in which changes in the states occur randomly through time, and probabilities of moves between particular states are governed by Markov transition matrices”. Towards this end, we will use the novel Income and Living Conditions Survey (SILC) panel data set to compute the transition probabilities of individuals moving across the labor market states of formal-salaried, informal-salaried, formal self-employed, informal self-employed, unemployed and inactive. The transitions analysis is conducted separately for two, three and four year panels pertaining to 2006 to 2007, 2006 to 2008 and 2006 to 2009 transitions; for total, male and female samples; and lastly for total and non-agricultural samples. In this way, we aim to contribute to the limited body of stylized facts available on mobility and informality in the Turkish labor market. Next, we conduct multinomial logit regressions individually for each set of panel to identify the impact of individual characteristics (i.e. gender, age, education level, work experience, sector of economic activity, firm size, number of other household members, having/not having children, rural/urban) underlying worker transitions. The results reveal several relationships between the covariates and likelihood of variant transitions, and are of remarkable importance for designing policy to address labor informality and reduce its negative externalities.
    Keywords: Labor market dynamics, informality, Markov processes, multinomial logit, Turkey
    JEL: J21 J24 J40 J63 O17
    Date: 2012–01
  3. By: Aysit Tansel (Department of Economics, METU); Elif Oznur Kan (Department of International Trade, Cankaya University)
    Abstract: In this study, we examine the formal/informal sector earnings differentials in the Turkish labor market using detailed econometric methodologies and a novel panel data set drawn from the 2006-2009 Income and Living Conditions Survey (SILC). In particular, we test if there is evidence of traditional segmented labor markets theory which postulates that informal workers are typically subject to lower remuneration than similar workers in the formal sector. Estimation of standard Mincer earnings equations at the mean using OLS on a pooled sample of workers confirms the existence of an informal penalty, but also shows that almost half of this penalty can be explained by observable variables. Along wage/self-employment divide, our results are in line with the traditional theory that formal-salaried workers are paid significantly higher than their informal counterparts. Confirming the heterogeneity within informal employment, we find that self-employed are often subject to lower remuneration compared to those who are salaried. Moreover, using quantile regression estimations, we show that pay differentials are not uniform along the earnings distribution. More specifically, we find that informal penalty decreases with the earnings level, implying a heterogeneous informal sector with upper-tier jobs carrying a significant premium and lower-tier jobs being largely penalized. Finally, fixed effects estimation of the earnings gap depict that unobserved individual fixed effects when combined with controls for observable individual and employment characteristics explain the pay differentials between formal and informal employment entirely, thereby implying that formal/informal segmentation may not be a stylized fact of the Turkish labor market as previously thought.
    Keywords: Earnings gap, formal/informal employment, labor market dynamics, panel data, Turkey
    JEL: J21 J31 J40
    Date: 2012–04
  4. By: Paula Herrera-Idárraga (AQR – IREA, University of Barcelona, Avda Diagonal, 690, 08034 Barcelona, Spain & Department of Economics, Pontificia Universidad Javeriana, Carrera 7 No. 40 – 62, Bogotá, Colombia.); Enrique López-Bazo (AQR – IREA, University of Barcelona, Avda Diagonal, 690, 08034 Barcelona, Spain & European Commission, Joint Research Center (JRC), Institute for Prospective Technological Studies (IPTS). Calle Inca Garcilaso 3, 41092 Sevilla, Spain.); Elisabet Motellón (AQR – IREA, University of Barcelona, Avda Diagonal, 690, 08034 Barcelona & Universitat Oberta de Catalunya, Avda Tibidabo 39-43, 08035 Barcelona, Spain.)
    Abstract: In this paper, we explore the connection between labor market segmentation in two sectors, a modern protected formal sector and a traditional- unprotected-informal sector, and overeducation in a developing country. Informality is thought to have negative consequences, primarily through poorer working conditions, lack of social security, as well as low levels of productivity throughout the economy. This paper considers an aspect that has not been previously addressed, namely the fact that informality might also affect the way workers match their actual education with that required performing their job. We use micro-data from Colombia to test the relationship between overeducation and informality. Empirical results suggest that, once the endogeneity of employment choice has been accounted for, formal male workers are less likely to be overeducated. Interestingly, the propensity of being overeducated among women does not seem to be closely related to the employment choice.
    Keywords: Segmented labor markets, Formal/Informal employment, Human capital, Economic development
    JEL: O15 J21 J24
    Date: 2012–11
  5. By: Haider, Adnan; Din, Musleh-ud; Ghani, Ejaz
    Abstract: This paper develops an open economy dynamic stochastic general equilibrium (DSGE) model based on New-Keynesian micro-foundations. Alongside standard features of emerging economies, such as a combination of producer and local currency pricing for exporters, foreign capital inflow in terms of foreign direct investment and oil imports, this model also incorporates informal labor and production sectors. This customization intensifies the exposure of a developing economy to internal and external shocks in a manner consistent with the stylized facts of Business Cycle Fluctuations. We then focus on optimal monetary policy analysis by evaluating alternative interest rate rules and calibrate the model using data from Pakistan economy. The learning and determinacy analysis suggest monetary authority in developing economies to follow Taylor principle in large and to put some weight on exchange rate fluctuations even if there is relatively less inertia in the setting of policy interest rate.
    Keywords: Monetary Policy; Informal Economy; Business Cycles; DSGE
    JEL: E32 E52 E26 E37
    Date: 2012–10–14
  6. By: Kodila-Tedika, Oasis; Agbor Agbor, Julius
    Abstract: To the extent that trust is necessary to conduct informal sector business activities, its absence could possibly constrain entrepreneurial spirit and overall economic growth. This paper tests the hypothesis that differences in trust levels between countries explain the observed differences in entrepreneurial spirit amongst them. Analyzing a cross-section of 60 countries in 2010, our findings suggest that about half of the variation in entrepreneurial spirit across countries in the world is driven by trust considerations. This result is robust to regional clustering and to alternative conditioning variables. The findings of the study suggest that while formal incentives to nurture entrepreneurship must be maintained, policy-makers should also pay attention to the role of trust cultivated through informal networks.
    Keywords: Entrepreneurship; Trust; Institutions
    JEL: D2 P48 L26 Z13
    Date: 2012–10–29
  7. By: Roberto Dell'Anno (Department of Economics and Statistics, University of Salerno); Désirée Teobaldelli (Department of Law, University of Urbino “Carlo Bo”)
    Abstract: This paper puts forward a framework for evaluating the effects of governmental decentralization on the shadow economy and corruption. The theoretical analysis demonstrates that decentralization exerts both a direct and an indirect impact on the shadow economy and corruption. Firstly, decentralization helps to mitigate government-induced distortions, thus limiting the extent of corruption and the informal sector in a direct way. Secondly, in more decentralized systems, individuals have the option to avoid corruption by moving to other jurisdictions, rather than going underground. This limits the impact of corruption on the shadow economy and implies that decentralization is also beneficial in an indirect way. As a result, our analysis documents a positive relationship between corruption and the shadow economy; however, this link proves to be lower in decentralized countries. To test these predictions, we developed an empirical analysis based on a cross-country database of 145 countries that includes different indexes of decentralization, corruption and shadow economy. The empirical evidence is consistent with the theory. Results are robust and significant even after controlling for the endogeneity bias.
    Keywords: Shadow economy, Federalism, Decentralization, Corruption.
    JEL: O17 H77 H11 D73
    Date: 2012
  8. By: Paolo Pellizzari (Department of Economics, University Of Venice Cà Foscari); Dino Rizzi (Department of Economics, University Of Venice Cà Foscari)
    Abstract: In this paper we present a model of tax compliance with heterogeneous agents who maximize their individual utility based on income and the conjectured level of per capita public expenditure. We formally include psychological drivers in this model. These drivers affect individual behavior, such as risk aversion, together with appreciation of public expenditure, expectations about peers’ compliance and a natural inclination to comply, all of which we summarize in a quality termed “citizenship”. The enforcement system, based on random inspections, is standard and only partially known to agents. The agent-based model is simulated under a variety of settings, representing different “societies”. We use the artificial data produced by the model to estimate the effects of taxpayers’ traits on personal tax behavior and to build a compliance societal slippery slope. At the individual level, we find a positive dependence of compliance on all variables, with the significant exception of the tax rate, which has a negative impact. As far as societies are concerned, we show how aggregate tax compliance depends on composite indices of citizenship and power, and we find that the former is more important than the latter.
    Keywords: Tax evasion, public expenditure, agent-based models
    JEL: H26 H40 C63
    Date: 2012
  9. By: Shaikh, Salman
    Abstract: This study used the simple co-integration technique to estimate the direct tax buoyancy for Pakistan economy for the 36 year period starting from FY-1974 to FY-2009. The buoyancy estimated was more than unity which represents slight improvement over previous estimates in past studies. The study attributes the improvement to factors such as expansion of tax base, diversification and deepening of manufacturing sector and structural change in the economy with the size of agriculture sector output shrinking as proportion of GDP and the proportion of direct tax increasing in proportion to total taxes gradually. The study recommends certain policy recommendations which include increase in tax base, reduction in tax rates, reducing tax evasion opportunities by taxing all sources of income and by increasing documentation through compulsory show of tax identity in making most material transactions.
    Keywords: Taxes; Fiscal Policy; Public Finance; Tax Buoyancy; Tax Elasticity; Tax to GDP Ratio
    JEL: E62 H2 H3
    Date: 2012–04–31
  10. By: Armstrong, Christopher S. (University of PA); Larcker, David F. (Stanford University); Ormazabal, Gaizka (University of Navarra); Taylor, Daniel J. (University of PA)
    Abstract: Prior research argues that a manager whose wealth is more sensitive to changes in the firm's stock price has a greater incentive to misreport. However, if the manager is risk-averse and misreporting increases both equity values and equity risk, the sensitivity of the manager's wealth to changes in stock price (portfolio delta) will have two countervailing incentive effects: a positive "reward effect" and a negative "risk effect." In contrast, the sensitivity of the manager's wealth to changes in risk (portfolio vega) will have an unambiguously positive incentive effect. We show that jointly considering the incentive effects of both portfolio delta and portfolio vega substantially alters inferences reported in prior literature. Using both regression and matching designs, and measuring misreporting using discretionary accruals, restatements, and SEC Accounting and Auditing Enforcement Releases, we find strong evidence of a positive relation between vega and misreporting and that the incentives provided by vega subsume those of delta. Collectively, our results suggest that equity portfolios provide managers with incentives to misreport when they make managers less averse to equity risk.
    JEL: G34 J33 M41 M52
    Date: 2012–08
  11. By: Ranis, Gustav (Yale University)
    Abstract: Unskilled labor is the abundant resource in many developing countries, especially at an early stage of their development. Yet, even as at given technologies labor markets have not cleared, neo-classical economists have rejected the notion of an institutional or bargaining wage not based on competitive full employment marginal productivity fundamentals. This paper puts to rest some objections to labor surplus theory based on "red herrings" and then addresses the substantive challenges from the micro-econometric branch of neo-classical economics. We contend that the finding of inelastic supply curves of labor is based on a cross-section static analysis of labor supply within agriculture while the labor surplus model deals with tracing the dynamic reallocation of labor from a traditional to a neo-classical organized sector in a dualistic economy. We present data for a number of labor surplus developing countries showing that institutional wages lag behind agricultural productivity increases as countries move towards a "turning point" when inter-sectoral balanced growth has eliminated unskilled labor and the economy has lost its dual characteristic.
    JEL: O10 O11 O17 O18 O41 O43 O57
    Date: 2012–09
  12. By: Dasgupta, Basab (World Bank); Zimmermann, Christian (Federal Reserve Bank of St. Louis)
    Abstract: We study the impact of loan regulation in rural India on child labor with an overlapping-generations model of formal and informal lending, human capital accumulation, adverse selection, and differentiated risk types. Specifically, we build a model economy that replicates the current outcome with a loan rate cap and no lender discrimination by risk using a survey of rural lenders. Households borrow primarily from informal moneylenders and use child labor. Removing the rate cap and allowing lender discrimination markedly increases capital use, eliminates child labor, and improves welfare of all household types.
    Keywords: child labor, India, informal lending, lending discrimination, interest rate caps
    JEL: O16 O17 E26
    Date: 2012–10

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