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Is trade influencing the degree of informality or the degree
of informality influencing the potential gains from trade:
Trade & Informality
(Trade – Informality – Development Interfaces)
Topics to cover
• Does Informality Matters? why
– Structure of informality (informal market segments)
– Employment/Income: Factor uses, factor prices & mobility
– Economic Activities/Units/Enterprises: changes with trade
• Trade, Informality & Dev Links: understanding the links
– theoretical & empirical studies to examine the links
– Factor use, Employment, Income, Distribution, Productivity
• Trade, Regulation, Formal‐Informal Eco & Dev
‐ Trade, Globalization, Informality, Production, Market forces
‐ Approaches, trends & Pattern
‐ Changes in informality Does trade increase/reduce informality
• Summary: Role of trade & dev policy
Informal Sector
Major Issue/Debate
• Can the informal economy would shrink with
economic growth and trade?
• Globalization and trade reforms have shown a
tendency to encourage precarious forms of work -
globalization and trade reforms lead to competition in the formal sector,
which may result in a reduction in formal employment
• Contrary to classical trade theories: trade liberalization
does not necessarily lead to rising welfare of unskilled labour
• Recent Trends: Outsourcing to informal sector
global value chains combine various modes of production (traditional,
semi-industrial and fully industrial production mechanisms)
• Trade, Informality & Employment: no clear trends, Impacts
• Role of Trade Policies & Dev Policies
Trade & Informality: Overview
• Dynamics of trade & informal sector exists: benefits, adjusts &
accommodates - presence of large informal sector on export competitiveness
• Trade expands with Informality: desire to comp/reduce costs
leads to informalization of production as well as employment
• Clear Division: formal (higher size, efficient, capital intensive, cater
to large external markets), reverse found for informal sector
• Trade liberalization increases informal Emp: the extent is
unclear; the impact on wages is ambiguous; the ability to benefit from
trade is unclear – careful to assess the informal economy for policy
• Trade Creates & Destroys jobs: in both sectors & creates new
jobs according to new demands (requires certain levels of education,
skill upgradation, opportunities for retraining)
• Informality & income inequality Links: Informality exists due to
income inequalities (UN DESA 2005) - rising trade, informality &
inequality in tandem
• Trade Models fail to capture: Gravity models used to see factors
determine trade but not used to assess effects of informality on trade
Share of Informal Economy in GDP
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Trade Openness & Informality in Asia FDI & Informality in Latin America

Globalization, Trade & Informality India’s Informal Sector: Share in GDP & Employment
• Globalization: benefits formal sector in DCs (Trade : GDP > 60%)
– limited effect in reducing labour market vulnerabilities in developing world
Services % of formal % informal % of informal
– prevent LDCs to enjoy full benefits of globalization (GDP) Employment
(GDP)
– Becomes new sources of external economic shocks
• Growth & High Informality Co-exists Construction 41.8 58.2 85.8
– Challenges from existence of informal Sector persists: Trade 18.1 81.9 84.7
– “varieties of informality” - Difficulty in determining its size and trends
• Informality: limits LDCs to benefit fully from world economy – Hotel & Restaurants 41.2 58.8 90.7
– larger informal economies experience lower export diversification low gains
Transport & Storage 35.2 64.8 79.3
– Constraints of small firm size, growth, productivity, & operational issues,
– vicious circle of higher rates of informality and rising vulnerability Communication 91.4 8.6 92.8
– Missing labour market benefits: poor coordination between labour market
& trade reforms Banking & Insurance 90.5 9.5 88.7
• Trade reforms & Labour market vulnerabilities: Real Estate, 18.6 81.4 89.9
– countries with vulnerable labour markets - created poverty traps
– Benefits/gains from trade, if its products are tradable & capital is mobile Other Services 69.5 30.5 87.3
across sectors

Informal Sector Output & Employment Share of Formal & Informal Employment in Organized &
Unorganized Sectors in Millions (% of total Employment)
Sectors Employment: 1999-2000

Informal Formal Total

Unorganized 3413 (86.0) 1.4 (0.3) 342.6 (86.3)
Organized 20.5 (5.2) 33.7 (8.5) 54.1 (13.7)
Total 361 (91.2) 35.0 (8.8) 396.8 (100)
Employment: 2009-10
Unorganized 385.1 (83.7) 2.3 (0.5) 387.3 (84.2)
Organized 42.1 (9.2) 30.7 (6.7) 72.9 (15.8)
Total 427.2 (92.8) 33.0 (7.2) 460.2 (100)

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Trade & Role of Informal Sector
– absorbs surplus labour, provides income-earning opportunities
– provides goods and services unavailable in formal sector
– helps in maintaining a low cost of living by providing cheaper sources
of food and services
– informal sectors in determining the pattern of employment
– working conditions & welfare of the informal sector workforce (workers
earning – welfare interlinks)
• Theoretical arguments:
– with economic growth, the informal economy would shrink
– liberalized trade policies produce positive effects on the economy and
informal sector
– theoretical literature on informal sector has not adequately examined
the consequences of trade/economic reforms - on the wellbeing of
population engaged in the informal sector
– contrary to classical trade theories, trade liberalization does not
necessarily lead to rising welfare of unskilled labour.
Trade Liberalization & Informal Economy:
• Earlier studies: primary role was to provide a livelihood for the urban
poor. later studies showed that informal economy plays other crucial
roles that aid overall eco dev
• Recent trends:
– globalization and trade reforms have shown a tendency to encourage
precarious forms of work – progressive casualization of workers
– formal sector in developing countries failed to absorb informal workers
and production processes as expected – contrast to DCs.
– globalization and trade reforms lead to competition in the formal sector
– it may result in a reduction in formal employment, at least in the short
run
– Expanding global value chains (combine various modes of production)
– production processes can be outsourced into the informal sector
– larger firms tend to capture a major part of capital, leaving little for
informal enterprises, which remain small scale and less productive
– Exclusion from social protection mechanisms and have a high
incidence of poverty
Informal Labour: key features
• Informal Labour: Labour use not governed by govt. regulations or
by collective agreement between workers & employers
• Formal Labour: regulated labour use and remuneration by
collective contract or laws
• ‘Dual Economy’: feature of LDCs(Lewis 1954): the process of
transferring labour from informal to formal sector by eco growth - to
reduce informal labour - but missing in many cases
• Gap in wage/employment/work conditions persists:
• Informality does not imply a particular mode or location of
labour use: rural-urban, old-new Entp, self-wage emp., casual-
regular, traditional-modern, skilled & unskilled
• Bulk of informal labour: self-emp. & casual wage labourer
– wage rate is not market determined
• Practically, unemployment non-exists among informal
workers – issue is underemployment, low wage, poverty
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Trade & Informal Economy:
• Empirical evidence:
– different liberalized policies produce diverse effects on informal wage
– these results are independent of the nature of capital mobility between
the informal and the formal sectors
– labour market reforms - likely to produce favourable effects on the
informal wage (contrary to the common wisdom)
– Informal labour market characterized by competitive wage formation
rather than unionized process of negotiations
– sharp rise in the size of informal sector during liberalized eco regime
– substantial adjustment costs in implementing economic & trade
reforms, particularly in the employment front (falling Empl due to trade
reforms in SA, LA & LDCs in the 1990s)
– insecurity for the formal sector (ILO, 2006): expanding informal sector
failed to absorb the retrenched formal workers due to trade reforms –
leading to steep rise in unemployment
– poverty has increased in India in the post-reform period (Khan 1998, and
Tendulkar et al. 1996)
Trade & Eco Reforms and Informal Sector
• The “informal economy” captures both employment
relations as well as enterprise relations
• “informal employment” refers to both the production unit
& the characteristics of the job or worker. It can affect
• (a) large informal economies may narrow the degree of
export diversification;
• (b) they may limit firm size and hence productivity
growth;
• (c) they may act as a poverty trap preventing successful
reallocation of jobs within the formal economy; and
• (d) they may provide cheap intermediate goods and
services that boost the competitiveness of formal firms in
international markets.
Type of Informal Employment (ILO)
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Type of informal employment (ILO)

• Own-account workers who have their own informal sector enterprises
Informal Employment by Regions
and no employees (cell 3 in above table).
• Employers with employees who have their own informal sector
enterprises (cell 4) (the informal nature of their jobs follows directly from the
characteristics of the enterprise).
• Contributing family workers, irrespective of whether they work in formal
or informal sector enterprises (cells 1 and 5).
• Employees who have informal jobs, whether in formal sector, informal
sector or as paid domestic workers by households (cells 2,6,10)
(employment relationship is not subject to standard labour legislation, taxation,
social protection or entitlement to certain employment benefits).
• Employees, who hire more than six to nine workers are generally
considered formal (cell 7).
• Members of informal producers’ cooperatives (cell 8) (not established
as legal entities).
• Persons engaged in the own-account production of goods exclusively
for own final use by their household (cell 9).

Informal Labour in India

Informality by Skill Level • Large & diverse informal sector & labour uses: growing
with trade liberalization
• Different other LDCs: India has two parallel economics (formal &
informal growing in tandem) rather than a dual economy
• High growth failed to shift informal labour to formal sector
(organized sector fail a process to shift informal labour)
– Labour saving tech use during trade liberalization (sign of DCs)
– Focus on capital intensive heavy industry (trade induced)
– Labour strategy & regulations: growth of wages not employment in
formal sector (biased policy)
– Pregressive capital intensive nature of labour intensive Mnf. (< L/K)
– Growth of informal labour income with informal worker- visible
poverty reduction, decline in child labour (7 to 2.5% 1980-10)
– Informal Wage not market determined but linked to avg income of
marginal worker in self-employment
– Agrl growth help modest improvement in informal emp. & poverty

Informal Labour in India 1978-20 Trade & Informal Economy: Theory & Empirics

• Growth of Trade & Informal sector:

– informal economy is diverse: less income, less job security, low skill, not
. skilled & capital intensive, - last resort for workers who cannot find a decent job
– Skill-biased nature of international trade
– Potential profitability and cost-cutting ventures
• Formal-informal sectors interlinks: different views
– Dualist views: no direct link exists (constraints on the labour
mobility, capital access, skill and wage differences, inferior informal
segment of the market, only formal economy can engaged in trade)
– Legalist views: exists because of rigid government regulations, and
to avoid costs associated with registration
– Structuralist views: residual strategy for those who are excluded, it
supplies cheap labour and inputs to larger formal firms
• New Case Studies: informal economy is structurally connected to
the formal economy - dual economy (Lewis, Todaro-Harris)

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Impact of Trade on Informal Economy: (Lit.)
• Does trade tend to change emp. in informal economy??
• Trade Impact & Informal Economy Models: based on
assumptions: produces final goods, both tradable & non-tradable goods;
existence of urban unemp., duality of credit markets, capital immobility
– Direct Impact of Capital mobility on informal wage: (Marjit & Acharyya,
2003) lack of capital mobility would constrain such informalization
– Tradable Good, Tariff Reduction & Rise in Informal Wage:
– With declining tariffs, the formal sector faces competition, thus its
return on capital decreases, informality may help suppliers
– opening up of trade may shift production to informal economy, where
wages remain stagnant or may even decline (Kar and Marjit 2001)
– with trade reallocation of production from formal to informal economy
occurs - workers in formal sector face threat of lay-off (Goldberg &
Pavcnik 2003)
– production in formal sector started specializing in goods for export –
so production of non-export goods shift to informal sector (Cimoli &
Porcile 2009)
Integrating Different Segments of Labour Market
• Segments of informal employment: combines elements from
the dualist, legalist and structuralist views: - Multi-segmented
labour markets (Chen, 2005; Fields, 2005),:
• Different segments of informal economy:
– Dualist: a lower-tier segment dominated by households engaging in
survival activities with few links to the formal economy
– Legalist: an upper-tier segment with micro-entrepreneurs who
choose to avoid taxes and regulations, as the legalists
– Structuralist: an intermediate segment with micro-fi rms and
workers subordinated to larger firms
• Relative importance of each of the segments may vary
across regions or countries
• Workers have access only to certain segments of labour
market depending on the size of their social network and
related bargaining power

Labour Market Segments & Flows between Formal Multi-Segmented Labour Market &
& Informal Sectors: Key Factors Flows between Formal & Informal Economy
• Institutional characteristics (taxes, labour law, business regulation,
labour relations, social networks); - determine the flow between the
different segments, i.e. both the direction of the flows and their relative
importance
• Individual characteristics (human capital, social relationships,
preferences); --- determine access to specific labour market segments -
barriers of entry to individual segments
• Firm-specific characteristics (location, size, sector of activity,
production networks);
• Market conditions (dynamics of domestic demand, macroeconomic
policies, trade openness, exchange rate developments); - will
determine labour demand in each of the segments
• Life-cycle considerations whereby workers transit between different
labour market segments to trade-off flexible working conditions against
stable wage growth depending on their age and age-related
preferences.

Assess Impact of Trade on Informality:

Impact of the informal economy on trade
Approaches
• Does country’s ability to benefit from international trade
with large informal sector?? • {mpact of trade policy changes on the informal economy
– Dualistic View: existence of large informal economies is • Qualitative studies: (micro case studies, partly using data).
detrimental to trade
• Quantitative ex post studies: (econometric analysis).
– Legalistic View: informality indicates the failure of the government
to address trade and economic development and, to this extent, • Quantitative ex ante studies: (computable general equilibrium
informalization can retard trade (CGE) models).
– Structuralist view: informalization indicates the limitations of the
economy in absorbing the gains from trade.
• Informal sector is an engine of growth (De Soto (1989):
subcontracting and using cheaper informal labour may
provide companies with a competitive advantage

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Impact: Qualitative Approach (micro-level field studies)
• Shinha (2017) Madagascar: decline in: (a) women’s participation in
the workforce; (b) the total number of self-employed and private informal
workers; and (c) the number of firms in the informal economy.
• Rising participation of women in EPZ: wages in EPZ, though
lower than in the formal sector, were higher than in the informal sector
• Marjit and Maiti (2005) W. Bengal: growth of dedicated export
sectors, the production units in the informal economy became tied to
formal units through various types of agent
• Singh and Sapra (2007) Textiles in Tirupur & Delhi: linked to
global value chain; casual migrant workers from lower castes are the
informal labour joined through contractors having no bargain power
• Informal Production System: division between “factory” and “home-
based” work, - the latter was a further subcontracted form of the former
• Low End Value Chain & Informality: division of work- better-paid
and skilled jobs going to males and lower paid jobs going to women
Can Trade Reduce Informality?
• Informality differentials: industry informality differentials,
differential tariff rates, emp & wage diff.
• Characteristics of Informality Varies: region, sector, nature of
trade & trade comp, labour market, period, domestic & external
volatility, Soc security measures, population, R-U links
• Aleman-Castilla (2006): industries more exposed to trade saw
higher increases in the rate of formality (Mexco), - offers an option of
producing either in the formal or the informal sector
• Productivity & Firm Heterogeneity: exposure to trade induces
only the more productive firms to export while forcing the least
productive informal firms to exit – Market share & profits are reallocated
towards formal firms
• Case of Mexico: joining NAFTA helped reduce informality. Increasing
trade competition from others (China) where Mexico has a comp.
advantage could lead to increasing informality
Impact of Polices & Regulations on Informality
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Impact: Empirical Quantitative Studies
• Tarde Liberalization Induces Informality: trade & informal emp.
and wages - depends on the labour market structure & flexibility
• With trade liberalization, employment not much of capital tends to be
tilted in favour of informal sector (LA, Mexico)
• Trade & Wage Differentials: it persist between formal and informal
economies despite the restructuring - leading increase in informalization
of employment not capital mobility
• Agenor and Aizenman (1994): formal employment depend on the
wage differentials between formal & informal sectors
• Bauch (1991): regulation and insistence on minimum wages creates
the formal-informal duality
• Fortin et al. (1997): trading countries to become more competitive,
reducing the wages of workers and cutting down on overheads -
informalizes both firms and employment
• Goldberg and Pavcnik (2003): mobility across the formal and
informal sectors within an industry is > mobility across industries
Do Trade Reforms Increased Labour Market
Vulnerabilities (in short run)?
• Economic theory: offers little in terms of strong predictions
regarding the effect of trade opening on informality
• Theoretical models: focused predominantly on cases where trade
opening leads to an increase in informal employment, discussing the
conditions under which informal wages will rise or fall
• Empirical Evidence: offer a better understanding of the linkages
between globalization and the informal economy
• Capital Mobility across sectors: benefits informal eco -increased
demand for its goods/services and informal wages could rise
• Tradability: Informal labour markets benefit from trade reforms if
their products were tradable directly on international markets – a
precondition that seems unlikely to be met in many countries
• Structural Changes: structural adjustment in the formal economy
following trade reforms may adversely affect informal economy – at
least in the short run (interlinked production chains)
• Globalization & Trade Integration: may to lead labour-abundant
countries to specialize in labour-intensive, low-skilled
i d ti i i f l kill d l b i d ki
Does Informality Influence Trade:
• Informality has an impact on the capacity of a country to
engage in trade and to grow – much is not known
• (a) large informal economies may narrow the degree of
export diversification;
• (b) they may limit firm size and hence productivity growth;
• (c) they may act as a poverty trap preventing successful
reallocation of jobs within the formal economy; and
• (d) they may provide cheap intermediate goods/services
that boost competitiveness of formal firms in world markets
• Informality may inhibit trade success as informal firms lack
the necessary size to fully exploit economies of scale
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Trade Openness, Informality & Labour Market
• Globalization & Trade Integration: no clear trend of increase in wages
for low-skilled labour & improved working conditions
• Skilled Labour: skill premium has increased both in DCs & in emerging
economies, making low-skilled workers (relatively) worse off –
• Demand for high-skilled labour: skill-biased technology change linked
to increase in skill premia
• Skill-biased technology & trade openness: empirical evidence shows
that trade opening has led to the development and diffusion of skilled-
biased technologies.
• Foreign Capital & MNCs: international investment is complementary to
the demand for high-skilled labour not low skilled labour
• Cross-country differences: differences in the sectoral reallocation of
both capital and labour, differences in policy implementation
– Latin American countries: these effects strongly depend on country-specific
circumstances
– Asia: structural change, factor market flexibility, domestic trade policy,
• Long Run Benefits: employment and wages
To Improve Informal Labour Conditions
• (a) support for employees to transit out of informality;
• (b) investment in infrastructure so as to promote
productivity of informal firms and facilitate formalization;
• (c) a basic network of social protection for those who
continue to be employed informally
• (d) Focus on skill, training & human development in
informal sector
• (e) implementing trade reforms with an eye on job
creation
• (f) exploiting complementarities between trade and
labour market reforms.
Urban Informal Sector
• Why growth of the urban informal sector?
– Generates surplus despite hostile environment
– Creating jobs due to low capital intensivity
– Access to (informal) training, and apprenticeships
– Creates demand for less- or un- skilled workers
– Uses appropriate technologies, local resources
– Recycling of waste materials
– More benefits to poor, especially women who are
concentrated in the informal sector
• Policies for the Urban Informal Sector
• Women in the Informal Sector
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Summary
• No Generalization: benefits of trade liberalization may not spread
over to unskilled labour in non-tradable sectors in labour surplus
countries
• Different Approaches, Methods, Data
– Cross-sectional data suggest that opening up of trade reduces
informality,
– Panel data suggests that the reverse is true.
– Micro-level data seem to suggest that lower tariffs and lower
restrictions reduce informality in countries.
• Emp vs Wage vs Output: Informal employment decreases with
deeper trade liberalization, while informal output increases with high
productivity.
• Trade Fluctuation can lead to Jobs creation & destruction in certain
sectors and the mobility between sectors,
• Outcomes of trade liberalization: depend on structure & specific
conditions of the individual economy rather nature of trade liberalization
The impact of trade on the informal sector
(Rural-Urban Links: Hariss-Todaro Model)
• Trade tends to increase R-U migration & informal emp.
• Dual economy model (Rural-Urban): wage differentials
and income expectations
• R-U Difference: by space, access to information, market principles,
bargaining power and structures of employment and capital
intensities.
• Growth of Urban Informal Sector:
– Urbanization
– Urban agglomeration
– Census towns/
– rural markets
Economic Theory of Rural-Urban Migration
• A Verbal Description of the Todaro Model
– Migration is a rational decision
– The decision depends on expected rather
than actual wage differentials
– The probability of obtaining a city job is
inversely related to the urban unemployment
rate
– High rates of migration are outcomes of rural
urban imbalances
• A Diagrammatic Presentation
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Harris-Todaro Migration Model
Economic Theory of Rural-Urban Migration
(cont’d)
• Five Policy Implications
– Reduction of urban bias
– Imbalances in expected income opportunities
is crucial
– Indiscriminate educational expansion fosters
increased migration and unemployment
– Wage subsidies and scarcity factor pricing
can be counterproductive
– Programs of integrated rural development
should be encouraged
Generalizing the Harris-Todaro Model
LM LM
WA  (WM )  (1 - )(WT )
LUS LUS
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Economic Theory of Rural-Urban Migration
(cont’d)
LM
WA  (WM )
LUS
Where
WA is agricultural income,
LM is employment in manufacturing
LUS is total urban labor pool
WM is the urban minimum wage
Generalizing the Harris-Todaro Model
• If informal-sector income is greater than zero, we
include it as a weighted component of expected
urban income (on the right side of Equation),
specifically we add (as in Endnote 30):
• The informal-sector wage WUI times the probability
of receiving it:
- WUI(1 - LM/LUS)
- where (1 - LM/LUS) is the probability of not receiving
the preferred urban formal wage.
• We can further elaborate with other wages for
different activities - and probabilities of receiving them
- in this period; and, more generally, in future periods