Globalisation and informality: The role of quality gap and social contributions

Abstract

AbstractWe investigate theoretically and empirically the effect of globalisation on informality. We use a model with two identical countries. Firms in each country choose to be formal or informal. Relative to an informal firm, a formal one produces a good of higher quality and pays social contributions on each worker. We determine the effect of globalisation on the size and the share of informality from the comparison of Autarky and Full Integration scenarios. We prove that for a given quality gap between formal and informal products, (i) globalisation increases the size of informality for low and high levels of social contributions but decreases it for intermediate ones; (ii) globalisation increases the share of informality for low social contributions and decreases it for high social contributions. The turning points depend increasingly on the quality gap. We then test these theoretical results by relying on the well‐informed data available for Latin‐American countries and using the economic sector as a proxy for the quality gap between a formal and an informal firm. Our empirical results are highly consistent with the theoretical model. In terms of policy implications, they show that globalisation may be used by the states together with modulated social contributions so as to reduce informality, but not for all economic sectors simultaneously.