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Structural Reform Packages, Sequencing, and the Informal Economy
Zsuzsa Munkacsi and Magnus Saxegaard
This paper expl ores the macroeconomic impa ct of labor and
product market deregul ation using a small-open-economy
model with formal and inform al markets. We examine both
the long-term ef fects and the transition toward post-reform
equilibrium, as well a s the impact of reform packages and
sequencing. Our model sugg ests that the size of the unofficial
sector is an important dete rminant of the impact of reforms.
South Africa, an eme rging market economy, is used as a
case study. In the long run, both labor and p roduct market
reforms boost the economy, though there are shor t-term
costs. A package of reform s, especially with product market
deregulation, coul d help mitigate some of these short-ter m
costs, though it is usu ally better to start with labor market
reforms to speed adju stment toward the new equilibrium.
Lackluster grow th in the aermath of the globa l
nancial cri sis, coupled with limited scope for furt her
macroeconomic stimulus, has re vived interest in the impact
of growth-enha ncing structural reforms. For exa mple,
European Central B ank President Mario Draghi recently
noted that, in addition to monetar y policy, “structural
reforms are key” to achiev ing prosperity.
Moreover, there has been a lot of focus recently on the
impact of widespread tax e vasion. e last of the three T’s
discussed at the Group of Eig ht summit in 2013 was ghting
tax evasion. G20 leaders i n November 2015 also endorsed
measures to crack down on fai lure to pay taxes.
Tax evasion, together with avoidance of compliance
with regulat ions (Williamson 1975), is a key challenge for
economies with a large in formal sector (Schneider, Buehn,
and Montenegro 2010). However, we are aware of only one
paper, Charlot, Malherbet, and Terra 2015, that looks at the
macroeconomic eect of struct ural reforms in the presence
of informality. Moreover, to the best of our knowledge,
there are no papers that ana lyze the interaction between
informality a nd trade openness.
e informal sector is , by denition, beyond government
reach and will t herefore not be directly aected by
deregulation, or indeed by any ot her public policies, such as
taxation. us, t he larger the informal sector, the smaller t he
share of the economy directly a ected by government actions.
In the absence of any lin kages between the formal
and informal sec tors, the overall macroeconomic eects
of government policies would therefore increase wit h
the relative size of the forma l sector. However, there are
potentially import ant linkages between the two sec tors,
and product and labor market reforms in t he formal sector
are therefore likely to have signic ant spillover eects for
the entire economy. Deregulation may discoura ge rms
and workers from operating in t he informal sector and
lead to an increase in t he relative size of the formal sector.
ere is also a productivit y dierential between the two
sectors, (Farrell 20 04; Bailey, Farrell, and Remes 2005; La
Porta and Shleifer 2008), which ca n magnify the impact
of structura l reforms. On the other hand, the informa l
economy may act as a shock absorber in the economy—for
example, by reducing the impact of adverse shock s on
unemployment (Boeri and Gariba ldi 2007). Also, rms
in the formal sector a re more likely than those in the
informal sector to engage i n trade with the rest of the
world. Structura l reforms that increase the relative size of
the formal sector could t herefore promote technology and
skills t ransfer, thereby leading to higher productivity.
Although it is dic ult to estimate precisely, what
evidence there is suggest s that the informal sector in many
countries is sizable, es pecially in emerging market and
low-income economies. For instance, Schneider (2005)
estimates that 16 percent of GDP of countries that are
members of the Organisation for Economic Co -operation
and Development and 41 percent of African countr ies’
GDP is generated in the informal se ctor. e share of
informal employment is likely h igher because rms
operating in the in formal sector are typically c oncentrated
in relatively labor-intensive industries (Schneider 2012).
Understanding the char acteristics of the informal economy
is therefore important for an overal l assessment of the
impact of structu ral reforms.
e structura l reforms we consider are permanent and
unexpected reduct ions in the level of product and labor