Informal Sector, Government Policy and Institutions
Abstract
We document cross-country differences in informal activity, government
policies and institutions using a data set covering 118 countries. Five key
facts emerge: better institutions are associated with lower inflation, higher
income tax rates and less informal activity and higher levels of informal
activity are associated with lower income tax rates and higher inflation. We
develop a general equilibrium model where households optimally choose the extent
of informal activity and a benevolent government optimally chooses policies,
both taking as given the institutions of the economy. The model is able to
account for most of the cross-country differences in policies and informal
activity as well as other key facts that emerge from the data. The performance
of the model is significantly reduced for various subsets of countries, where
some its key assumptions are likely to be violated.
First Draft : September 2009
Press Mentions
Econ Browser (James Hamilton's Blog) [May 16, 2010]
Wall Street Journal Website [May 17, 2010]