Corruption in a model of vertical linkage between formal and informal credit sources and credit subsidy policy

The present note develops a model of vertical linkage between the formal and informal credit markets highlighting the presence of corruption in the distribution of formal credit. The existing dominant moneylender, the bank official and the new moneylenders move sequentially. The existing moneylender acts as a Stackelberg leader and unilaterally decides on the informal interest rate. We show that there may arise a case where an increase in the supply of formal credit results in an increase in the informal interest rate under reasonable parametric restrictions. This shows that apart from (i) asymmetric information on the part of informal sector lenders (Bose, 1998), (ii) an increase in the probability of default of all informal sector lenders (Hoff and Stiglitz 1997), and the (iii) possibility of informal lenders to collude (Floro and Ray 1997), the presence of corruption in the distribution of formal credit might be another factor responsible for the policy of vertical linkage to break down.     

Economic reform and informal wage—a general equilibrium analysis

We attempt to trace the consequences of liberal economic policies on informal wage in a general equilibrium model with formal informal labor markets, wage-differential, vertical linkage and restricted capital movement. In particular, we show that the informal wage, representing income for a vast segment of unskilled labor may actually increase even if more people are employed in the informal segment. This also confirms that a contraction in the formal sector employment and the consequent expansion in the informal segment do not necessarily imply impoverishment of the existing set of informal workers.     

Institutions and the Relation between Corruption and Economic Growth

We study the effects of bureaucratic corruption on economic growth in a framework that takes into account that corruption also affects growth through its impact on institutions. We use a formal growth framework in which corruption affects growth negatively because of individual rent‐seeking and stealing of public goods, but where corruption may serve a positive role by taking over the role of institutions. We find that the overall effect of corruption on economic growth is highly dependent on the institutional setting of a country. Particularly in situations where institutions are not well developed corruption may be conducive to economic growth. We also find that the interaction among institutions themselves matters. This underscores the importance of taking into account the complete institutional setting when studying corruption, both in theory as well as empirically.     

Trade Reform and Informal Wages

When trade reform contracts protected formal sectors in developing countries and the formal workers move to the informal sector for employment, does that reduce informal wages? Using a 2 × 2 Heckscher–Ohlin–Samuelson (HOS) structure with formal–informal production organization for the same commodity, we show that a tariff cut in the import‐competing sector increases both informal wage and employment under very reasonable assumptions. An increase in the price of the export commodity will also increase informal wages, although aggregate informal employment unambiguously falls even if the informal export sector is labor intensive. Furthermore, the formal–informal segmentation of each sector opens up an interesting, hitherto unexplored, possibility that the informal export sector may contract despite a price increase in this sector. Change in the overall size of the export sector is also ambiguous and conditional on the relative strengths of changes in these two segments.     

Economic liberalization, capital mobility and informal wage in a small open economy: A theoretical analysis

Empirical evidence suggests that the size of the informal sector in the developing countries has increased considerably during the liberalized economic regime. The present paper purports to analyze the consequences of economic reforms on the wellbeing of the informal sector workforce using a three-sector general equilibrium model with two informal sectors. The theoretical analysis finds that different liberalized policies produce diverse effects on the informal wage and that these results are independent of the nature of capital mobility between the informal and the formal sectors. It also shows that labour market reforms, contrary to the common wisdom, are likely to produce favourable effects on the informal wage.     

Interaction of formal and informal financial markets in quasi-emerging market economies

The primary objective of this paper is to investigate the interaction of formal and informal financial markets and their impact on economic activity in quasi-emerging market economies. Using a four-sector dynamic stochastic general equilibrium model with asymmetric information in the formal financial sector, we come up with three fundamental findings. First, we demonstrate that formal and informal financial sector loans are complementary in the aggregate, suggesting that an increase in the use of formal financial sector credit creates additional productive capacity that requires more informal financial sector credit to maintain equilibrium. Second, it is shown that interest rates in the formal and informal financial sectors do not always change together in the same direction. We demonstrate that in some instances, interest rates in the two sectors change in diametrically opposed directions with the implication that the informal financial sector may frustrate monetary policy, the extent of which depends on the size of the informal financial sector. Thus, the larger the size of the informal financial sector the lower the likely impact of monetary policy on economic activity. Third, the model shows that the risk factor (probability of success) for both high and low risk borrowers plays an important role in determining the magnitude by which macroeconomic indicators respond to shocks.     

THE TWO‐WAY RELATIONSHIP BETWEEN GOVERNMENT SPENDING AND CORRUPTION AND ITS EFFECTS ON ECONOMIC GROWTH

The existing empirical evidence suggests that in low‐income economies, an increase in government spending leads to a reduction of growth. This article aims to explain this empirical fact by considering a growth model that incorporates a two‐way relationship between corruption and government spending. That is, government spending gives rise to corruption and rent seeking, which feeds back by distorting the structure and size of government spending. In addition, the cost of corruption depends on the wage rate. Therefore, in low‐income economies, increases in government spending tend to generate larger social losses caused by a higher level of rent dissipation and a concomitant rise in corruption and government inefficiency. Consequently, in such economies, an increase in government spending is more likely to result in a decline of economic growth. (JEL H3, O11, O41)     

CROSS‐COUNTRY EVIDENCE OF CORRUPTION SPILLOVERS TO FORMAL AND INFORMAL ENTREPRENEURSHIP

Using cross‐country data this paper examines the spillovers of corruption to formal and informal entrepreneurship in neighboring countries. Whereas research has shown that entrepreneurs move underground to escape corruption, we argue that entrepreneurs may also seek refuge in neighboring countries. Indeed, the empirical results show that in response to a ceteris paribus increase in corruption in neighboring countries formal entrepreneurship increases in the home country with no effect on informal entrepreneurship. This is consistent with entrepreneurs circumventing corrupt public officials by immigrating to countries with presumably less corruption. These results withstand a battery of robustness checks. (JEL D73, L26)     

Cross‐Subsidies,and the Elasticity of Informality to Social Expenditures: The Case of Mexico's Seguro Popular

How is the size of the informal sector affected when the distribution of social expenditures across formal and informal workers changes? How is it affected when the tax rate changes along with the generosity of these transfers? In our search model, taxes are levied on formal‐sector workers as a proportion of their wage. Transfers, in contrast, are lump‐sum and are received by both formal and informal workers. This implies that high‐wage formal workers subsidize low‐wage formal workers as well as informal workers. We calibrate the model to Mexico and perform counterfactuals. We find that the size of the informal sector is quite inelastic to changes in taxes and transfers. This is due to the presence of search frictions and to the cross‐subsidy in our model: for low‐wage formal jobs, a tax increase is roughly offset by an increase in benefits, leaving the unemployed approximately indifferent. Our results are consistent with the empirical evidence on the recent introduction of the “Seguro Popular” healthcare program.     

Informality,public employment and employment protection in developing countries

This paper proposes an equilibrium matching model for developing countries’ labor markets where the interaction between public, formal private and informal private sectors are taken into account. Theoretical analysis shows that gains from reforms aiming at liberalizing formal labor markets can be annulled by shifts in the public sector employment and wage policies. Since the public sector accounts for a substantial share of employment in developing countries, this approach is crucial to understand the main labor market outcomes of such economies. Wages offered by the public sector increase the outside option value of the workers during the bargaining processes in the formal and informal sectors. It becomes more profitable for workers to search on-the-job, in order to move to these more attractive and more stable types of jobs. The public sector therefore acts as an additional tax for the formal private firms. Using data on workers’ flows from Egypt, we show empirically and theoretically that the liberalization of labor markets plays against informal employment by increasing the profitability, and hence job creations, of formal jobs. The latter effect is however dampened or even sometimes nullified by the increase of the offered wages in the public sector observed at the same time.     

The effect of informal employment and corruption on income levels in Brazil

This paper exploits a unique dataset on corruption and informal sector employment in 476 Brazilian municipalities to estimate whether corruption impacts GDP or income levels once variation in informal economic activity is taken into account. Overall, I find that higher levels of corruption and a large informal economy are generally associated with poor economic outcomes. However, only the size of the informal economy has a statistically significant effect. This effect is robust to the inclusion of a variety of controls and fixed effects, as well as an instrumental variable analysis. Further, these effects are large in magnitude. For example, a one standard deviation increase in the share of total employees that are informally employed explains a decrease in GDP per-capita of about 18%.     

Earnings inequality and the informal economy

We analyse the extent and evolution of informality and inequality in the Serbian labour market between 2002 and 2007, using data from the Living Standard Measurement Surveys. Two surprising results emerge. First, the level of informal employment has risen significantly over the period, despite strong economic growth and the introduction of a range of market‐oriented reforms. Secondly, the level of inequality in earnings seems to have remained more or less constant over the period, in contrast to the experience of other countries at a similar stage of transition. We show that informal employees earn significantly less than those in the formal sector, controlling for a range of other variables, and informality plays an increasingly important role in explaining earnings inequality.     

Do the Effects of Corruption upon Growth Differ Between Democracies and Autocracies?

Many studies examining whether corruption lowers economic growth do not consider if the effects of corruption differ across countries. Whether corruption produces the same effects everywhere or whether its effects are conditional on some country characteristics are important questions. We investigate the association between corruption and growth, where the marginal impact of corruption is allowed to differ across democratic and nondemocratic regimes. Using cross‐country, annual data from 1984 to 2007, we regress growth on corruption, democracy and their interaction. We find that decreases in corruption raise growth but more so in authoritarian regimes. Possible reasons are that in autocracies corruption causes more uncertainty, is of a more pernicious nature, or is less substitutable with other forms of rent seeking.     

The Effect of Fiscal Decentralization on Corruption: A Non‐linear Hypothesis

This study advances the literature on the effect of decentralization on corruption by proposing a theoretical motivation for the hypothesis that the corruption‐minimizing decentralization arrangement prescribes intermediate decentralization degrees: a ‘middle’ decision‐making power of local governors may mitigate the tradeoff between the rent‐seeking incentive for local politicians and the effectiveness of their voters’ monitoring. The estimation of a non‐linear empirical model strongly confirms that a decentralization degree between 15% and 21% minimizes corruption even through different estimation procedures, introduction of control variables and the use of internal and external IV and of alternative decentralization and corruption measurements.     

The effects of economic reforms on manufacturing dualism: Evidence from India

Dualism is a pervasive feature of the manufacturing sectors of less-developed countries, with large differences in productivity between the informal and the formal sectors. Policy distortions are viewed as an important factor behind the prevalence of manufacturing dualism. We examine whether tariff reforms, industrial de-licensing and the withdrawal of reservation of products for small firms implemented since the mid-1980s have had any effects on efficiency differentials between informal and formal firms in Indian manufacturing. We find strong evidence that economic reforms have exacerbated dualism by increasing the productivity differentials between the more efficient formal firms and the less efficient informal firms.     

Some effects of business environment on retail firms

This paper empirically tests how formal retail entrepreneurs’ perception about the business environment in Cameroon affects the performance of the retail sector. I use business owners’ responses from the 2009 Enterprise Survey to estimate an econometric model that corrects for heteroscedasticity. The results show that regulation costs, corruption, credit constraints, and lack of infrastructure negatively affect the gross margins of firms. In contrast, the competition of the informal sector – perceived by many formal entrepreneurs as a major constraint – is positively associated with the gross margins of formal firms. Policy implications are discussed.     

Education,Rent seeking and the Curse of Natural Resources

Empirical evidence suggests that natural resources breed corruption and reduce educational attainments, dampening economic growth. The theoretical literature has treated these two channels separately, with natural resources affecting growth either through human capital or corruption. In this article, we argue that education and corruption are jointly determined and depend on the endowment of natural resources. Natural resources affect the incentives to invest in education and rent seeking that in turn affect growth. Whether natural resources stimulate growth or induce a poverty‐trap crucially depends on inequality in access to education and political participation, as well as on the cost of political participation. For lower inequality and higher cost of political participation, a high‐growth and a poverty‐trap equilibrium coexist even with abundant natural resources.     

Effect of subsidy and entry into the informal sector with interlinkage

The present paper focuses on the dualism that exists within the industrial sector. It develops a model of informal sector incorporating its linkage with the formal sector. In this paper the products of the two sectors are imperfect substitutes as products of informal firms are deemed to be of inferior quality compared to the formal sector product. Also the formal sector producer is the dominant producer whereas the informal producers constitute a competitive fringe. In this framework the effect of entry within the informal sector and the effect of a subsidy provided to the informal producers are studied.     

Economic reform,informal–formal sector linkages and intervention in the informal sector in developing countries: A paradox

Within a general equilibrium framework of a developing economy with a foreign owned factor of production, this paper questions whether the informal–formal sector relationship is pro-cyclical/complementary – expansion or contraction in one necessarily implies an expansion or contraction in the other – when the informal sector is subject to a technological shock. We derive a necessary and sufficient condition under which a positive shock to the informal sector results in an emphcontraction in both the size of the urban formal sector and the informal sector. Thus, although our result shows that the informal–formal sector relationship is pro-cyclical, it nevertheless calls into question the conventional wisdom on the benefits of intervention in the informal sector of developing economies, particularly where multinational corporations sub-contract certain labor-intensive stages of production to the informal sector.     

International Trade,Migration and Unemployment – The Role of Informal Sector

This paper provides an elaborate general equilibrium framework by including informal economic activities in a model of trade, migration and unemployment. Existence of informal activities is critical in generating positive employment effects of liberal trade policies. Following a tariff cut informal wage increases and rate of unemployment goes down under reasonable conditions. Next we generalize the benchmark model to capture the phenomenon of sequential migration: from agriculture to urban informal sector, and then to urban formal sector. Positive employment effect of reformatory trade policy partly owes to the fact that the presence of informal sector directly reduces the cost of migration and, hence, further induces the process of outmigration from agricultural sector. The paper also extends the benchmark model to include both informal intermediate and final good.