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Informality in the Process of Development and Growth
October 27, 2016DECRG Kuala Lumpur Seminar Series

“Informality” is a term used to describe the collection of firms, workers, and activities that operate outside the legal and regulatory systems. It is widespread in the majority of developing countries – in a typical developing economy, the informal sector produces about 35 percent of GDP and employs 70 percent of the labor force. This paper studies informality in the context of economic development by presenting a model and projections that link informality, regulations, migration, and economic growth.

This analytical framework highlights the trade-offs between formality and informality, the relationship between the different types of informality, and the connection between them and the forces of labor, capital, and productivity growth. The paper models the behavior of the informal sector based on the following fundamental asymmetry: Formal firms confront higher labor costs while informal firms face higher capital costs and lower productivity.

Using mandated minimum wages as the policy-induced distortion, the model first studies the static allocation of formal and informal capital and labor in a modern economy. Second, it opens the possibility of labor migration from a rudimentary economy with ample supply of labor (e.g., rural areas or less advanced neighboring countries). Third, the model analyzes the dynamic behavior of the formal and informal sectors, considering how they affect and are affected by economic growth and labor migration. Then, the paper presents projections for the size of labor informality, in the modern and rudimentary economies, in the next two decades for a large group of countries representing all regions of the world. The projections are based on the calibration and simulation of the model and serve to discuss its usefulness and limitations.

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  • Norman Loayza

    Lead Economist, Development Research Group, World Bank
    Norman Loayza is a Lead Economist in the Development Research Group at the World Bank. Recently, he was director of the World Development Report 2014, Risk and Opportunity: Managing Risk for Development. His research has dealt with various areas of economic and social development, including macroeconomic management, economic growth, microeconomic flexibility, private and public saving, financial depth and stability, natural disasters, and crime and violence. His advisory experience at the World Bank has also ranged across different topics in various regions and countries. A few examples include business environment and economic performance in Latin America; informal and labor markets in the Middle East and Northern Africa; public infrastructure gaps in Pakistan and Egypt; savings for macroeconomic stability and growth in Sri Lanka, Georgia, and Egypt; and pro-poor growth in Indonesia and Peru. On external service from the World Bank, he was a Senior Economist at the Central Bank of Chile (1999-2000), where he advised on financial and monetary policy. Norman has edited 9 books and published about 40 papers in professional journals and edited volumes. A Peruvian national, he holds a Ph.D. in economics from Harvard University (1994).
  • WHEN: Thursday, October 27, 2016; 12:30-2:00PM
  • WHERE: World Bank Malaysia Office, Level 3, Sasana Kijang, No. 2, Jalan Dato’ Onn
  • RSVP: Kindly RSVP by Wednesday, October 26, 2016