Working Paper: CEPR ID: DP5545
Authors: Alberto Chong; Mark Gradstein
Abstract: This paper presents theory and evidence on the determinants of the size of the informal sector. We propose a simple theoretical model in which it is positively related to income inequality, more so under weak institutions, and is negatively related to the economy's wealth. These predictions are then empirically validated using different proxies of the size of the informal sector, income inequality, and institutional quality. The results are shown to be robust with respect to a variety of econometric specifications. We also find that government interventions through taxes and regulations lose much of their robustness in the presence of the above factors.
Keywords: inequality; informal sector; institutional quality; shadow economy
JEL Codes: D70; O15; O17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Income Inequality (D31) | Size of the Informal Sector (E26) |
| Institutional Quality (L15) | Size of the Informal Sector (E26) |
| Income Inequality + Institutional Quality (D31) | Size of the Informal Sector (E26) |
| Government Interventions (H53) | Size of the Informal Sector (E26) |