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Trade and Employment: From Myths to Facts sector emerges because the formal sector cannot serve the highly segmented and differentiated market for goods and services. Sinha and Adam (2006) study India through a labour-segmented CGE model and find that casualization of work leads to loss of labour welfare and a reduction in the wages of informal workers. The study by Agenor et al. (2003) uses the integrated macroeconomic model for poverty analysis (IMMPA) to analyse rural and urban areas as the poor recover from the effects of earlier financial policies and the transmission of external shocks. Other CGE studies that analyse the impact of policy changes on the informal economy include Savard and Adjovi (1997), Sinha (1999), and Sinha and Adam (2000). CGE models CGE models are theoretically founded upon neoclassical theories. Such models are generally short term with a comparative-static framework using mainly relative prices for commodities with excess capacity so that prices and quantities adjust to changes in demand and markets are cleared. However, dynamic CGE models can also be developed that have potentially longer time-period analysis, since many variables may have different trajectories over the longer term. In both static and dynamic models, consumers are utility maximizers while producers are profit maximizers. Circular flow of income between firms and the household is incorporated, as is the government, though the latter is not an optimizer. The standard feature of such models consists of an imperfect substitution between imports and domestic demand for goods, known as the Armington assumption. Firms are assumed to be perfectly competitive, produce a homogenous output with imperfect transformability between production for domestic and foreign markets at the sectoral level, determined by a constant elasticity of transformation function. The treatment of export and import in such models allows autonomy to the domestic prices to adjust to changes in the world prices of sectoral substitutes and assumes that the country under consideration cannot affect world prices. Such models are often used for developing countries to observe the impact of structural adjustment on economies. The CGE is a model in which micro-level decision-making parameters of firms can be related to the macro-level policies of countries. In these models, factors of production, mostly labour and sometimes land and capital, are assumed to behave differently for different markets. Though full employment and perfect mobility of factors of production are possible in the long run, in the short run, capital is assumed to be fixed for each sector and immobile across sectors, thus possibly creating excess and unutilized capacities. Aggregate domestic demand in such models has four components, namely: consumption, intermediate demand, government and investment. The major macroeconomic parameters that are supposed to balance are savings and investments and government deficit and balance of trade. Markets for goods and services respond to the forces of the market, and market forces are affected by government policies and the external environment. The CGE and other general equilibrium models are usually Walrasian in nature with all markets in balance. Each sector produces a fully differentiated good so that there is no overlap. The goods are produced through various combinations of labour and 148
Chapter 4: Trade and the informal economy capital with constant elasticity of substitution (CES). The domestic output of the sector is derived from a CES function of factor inputs and the intermediate good used in the sector. Chapter 3 of this book discusses further details of CGE models used in relation to trade policy analysis. Application of CGE models to the informal economy The CGE models characterize informality through various markets. The assumptions underlying these characteristics depend on concepts regarding informality in goods markets and factor markets. Hence, it is important to conceptualize the differences of the output of the formal and informal sectors for modelling purposes and to build the specifications carefully. Even when formal and informal output is similar, it has been observed from field studies that product differentiation and imperfect substitutability between the two sectors often exist. Informal entrepreneurs generally do not cater to a large market, can have differences in the quality of goods and can occupy different outlets (e.g. streets as vendors, flea markets) as compared to the formal retailers. Another example involves exclusive goods, where limited market size precludes efficient formal sector production. These factors need to be built into a CGE structure. In order to capture these differences in the model, the outputs of the two sectors are treated as imperfect substitutes in many CGE models. Relative prices and the degree of substitution between the outputs of the respective sectors determine the composite good’s make-up in each sector’s output. Regarding the input factors, there could be two types of capital, one in the formal and the other in the informal economy. The CGE models incorporating the informal distinction also need to distinguish labour by informality. Various types of labour could be identified as either formal or informal. A CGE model for India The CGE work by and Sinha and Adam (2006) for India includes four key aspects on informality. First, there is product differentiation between the informal and formal sectors as they are shown to produce very different products. Second, the formal and informal economies use different technologies. Third, the formal and informal factors of production are distinct, especially since the formal wage is rigid. Finally, the informal sector does not pay taxes on the factor incomes. The model identifies ten sectors. Agriculture and construction are wholly informal while government and capital goods sectors are wholly formal. The rest, namely manufacturing, services and agro-processing have both formal and informal units. Both the formal and the informal units export, and both use informal factors. Total capital is fixed by sectors. The model is set up in two versions, one in which full employment is assumed and the other in which wages are rigid in the formal sub-sectors while they are totally flexible in the informal economies, and workers from the formal sector can join the informal sector. The simulations quantify the employment effects of two types of trade reforms: a revenue-neutral 60 per cent tariff reduction across the board, and a corresponding reduction of quantitative restrictions where they exist. The main findings of this exercise are that trade reforms lead to an inter-sectoral balancing of production away from 149
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Trade and Employment From Myths to
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Trade and Employment From Myths to
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PREFACE Trade negotiations -bilater
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Trade and Employment: From Myths to
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EDITORS AND CONTRIBUTORS EDITORS Ma
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ACKNOWLEDGEMENTS The editors wish t
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NEW EVIDENCE ON TRADE AND EMPLOYMEN
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Chapter 2: New evidence on trade an
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Region Annualized percentage change
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Region 1980 1985 1990 1995 2000 200
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Figure 2.4.b: Long-run association
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20 See Harrison and Rodriguez-Clare
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ASSESSING THE IMPACT OF TRADE ON EM
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REFERENCES Chapter 5: Gender aspect
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