Working Paper: NBER ID: w28391
Authors: Rafael Dix-Carneiro; Pinelopi K. Goldberg; Costas Meghir; Gabriel Ulyssea
Abstract: We examine the effects of international trade in the presence of a set of domestic distortions giving rise to informality, a prevalent phenomenon in developing countries. In our quantitative model, the informal sector arises from burdensome taxes and regulations that are imperfectly enforced by the government. Consequently, smaller, less productive firms face fewer distortions than larger, more productive ones, potentially leading to substantial misallocation. We show that in settings with a large informal sector, the gains from trade are significantly amplified, as reductions in trade barriers imply a reallocation of resources from initially less distorted to more distorted firms. We confirm findings from earlier reduced-form studies that the informal sector mitigates the impact of negative labor demand shocks on unemployment. Nonetheless, the informal sector can exacerbate the adverse welfare effects of economic downturns, amplifying misallocation. Last, our research sheds light on the relationship between trade openness and cross-firm wage inequality.
Keywords: Trade; Informality; Labor Market Frictions; Regulations
JEL Codes: F14; F16; J46; O17
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trade openness (F43) | informality in the tradable sector (J46) |
| trade openness (F43) | aggregate informality (J46) |
| omitting informal sector (J46) | understatement of productivity gains (O49) |
| trade openness (F43) | welfare gains (D69) |
| repressing informality (O17) | productivity (O49) |
| repressing informality (O17) | employment and welfare (J68) |
| incorporating informal sector (O17) | trade effects on wage inequality (F16) |
| informal sector (J46) | unemployment buffer (J65) |