Growing apart or moving together? Synchronization of informal and formal economy cycles

Vol: 
77/2021
Author name: 
Elgin C
Kose MA
Ohnsorge F
Yu S
Year: 
2021
Month: 
September
Abstract: 

We study the degree of synchronization between formal- and informal-economy business cycles. Using a comprehensive database of informal activity that covers a wide range of informality measures from almost 160 countries over the 1990-2018 period, we report two major results. First, fluctuations in informal-sector output are strongly positively correlated with those in formal-sector output. In contrast, fluctuations in informal employment are largely uncorrelated with those in formal-sector output. Second, movements in the formal economy tend to spillover to the informal economy. Using a novel set of instrumental variables, we show that fluctuations in formal-sector output “cause” movements in informal-sector output.

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