Shifting Shadows
Measuring the Unobservable
Exploring informal sector estimation techniques and dynamics in the context of macroeconomic stability and resilience.
Abstract
In a five-step approach, this paper investigates the contribution of the informal sector to macroeconomic resilience and stability. First, a comprehensive literature review on informal sector dynamics and correlates is conducted. Secondly, a selection of informal sector quantification techniques (DGE, MIMIC, SEmp, Pension, IEmp1, IEmp2, IInception, Comp) is highlighted. Thirdly, the data’s validity and consistency are statistically assessed. Fourthly, the volatility of informal sectors is evaluated across development stages and in relation to formal sectors. Fourthly, a novel database on informal sector crises (split into recession and recovery) is algorithmically generated and analyzed. Fifthly, the generated data is fed into a regression that determines the effect of informal sector size on macroeconomic resilience. The investigation concludes that the contribution of the informal sector to macroeconomic resilience and stability differs temporally. During short-run recessions, informal sectors (output and employment) generally contract more and experience greater economic loss than formal sectors. In contrast, informal sectors (output and employment) experience less economic loss upon crisis recovery. This provides evidence for the notion of the “economic buffer” effect which has two key features; firstly, recessions are dampened in formal sectors at the expense of amplified losses in the informal economy. Secondly, crisis recoveries are driven by a quick re-uptake of post-recession informal activity. In the long-run, evidence shows that less developed economies where informal sectors tend to be larger are generally more volatile (by output and employment). In aggregate and across development trajectories, informal sector size is associated negatively with macroeconomic resilience. Thus, policy should pursue long-run formalization efforts and engage in countercyclical intervention during recessions while simultaneously safeguarding the capacity of informal sectors to drive crisis recoveries.