Trade and Employment From Myths to Facts - International Labour ...

Chapter 4: Trade and the informal economy
and hence informalization indicates the limitations of the economy in absorbing the
gains from trade. However, the possibility of subcontracting and using cheaper informal
labour may provide companies with a competitive advantage and, thus, may
have a positive impact on exports. De Soto (1989) and others suggests that the
informal sector is an engine of growth.
Empirical analysis 2
Empirical analysis of the impact of informality on the capacity to benefit from trade
is rare. However, a related literature strand that has looked at informality, growth and
inequality provides some insights. Most of the studies suggest that a large informal
sector has an adverse effect on international trade. Short-term cost advantages may
be possible, but this appears to be at the expense of longer-term dynamic gains.
Several studies attribute adverse effects to the small size of entities in the informal
sector. La Porta and Shleifer (2008) observe that the informal economy, due to the
small size of firms, is less likely to find good talent and hence economies with a predominance
of such firms are not likely to specialize or become competitive enough
to benefit from trade. Elbadawi and Loayza (2008) find that, in Arab countries, informality
has negative marginal effects on small enterprise performance and conclude
that informal establishments have difficulties penetrating regional or international
markets. Smaller firms cater to local markets and larger firms are more likely to serve
international markets. In the case of such neat divisions, the informal economy must
become formal in order to be able to participate in global trade. Such a process of
formalization may require easier access to credit, capital and skills. In another study,
Inshengoma and Kappel (2006) observed that home-based production usually comes
with marginalization of economic resources and economic agents by limiting their
access to social services and also to capital. This phenomenon therefore tends to
impact trade adversely, since such micro-firms are not able to function in a competitive
trading framework.
Some studies find a positive effect on trade, often linked to subcontracting.
Carr and Chen (2002) recognized the potential of the informal economy to help expand
opportunities in trade in cases where firms are vertically linked with the formal
sector – such as outsourcing and subcontracting. The informal economy, as observed
by the authors, helps to minimize production costs and overheads. Under some conditions,
positive effects are also found in studies reflecting the dualistic approach.
Davis and Haltiwanger (1990, 1992), and Davis et al. (1996), observe that informality
helps trade, provided job switches are possible from the informal to the formal sector
with skill upgrading and new skills. Trade destroys jobs in both sectors and creates
new ones according to new demands. This requires certain levels of education, opportunities
for retraining, and so on.
2 Although section 4.3 discusses theories and concepts, empirical results of the impact of informality
on trade is discussed here since the literature on this topic is small.
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