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Is the devil in the shadow? The effect of institutional quality on income

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  • Israt Jahan
  • Jamie Bologna Pavlik
  • Ryan Blake Williams

Abstract

The positive relationship between institutional quality and “official” income is well documented. It is unclear, however, whether this relationship holds once the “unofficial” economy is accounted for. An improvement in institutional quality tends to shift production out of the shadow and into the official sector, resulting in an increase in official income. However, this shift comes at the expense of the informal economy, potentially negating the perceived gains in output. This paper uses data from 5,506 Brazilian municipalities to explore the effects of institutional quality on total income per person. We additionally estimate the effect of institutions on informal sector size. Our most robust finding suggests that higher‐quality institutions using our broadest measure are significantly related to development. While good institutions do decrease the size of the informal sector, the consequential switch to formality raises overall productivity.

Suggested Citation

  • Israt Jahan & Jamie Bologna Pavlik & Ryan Blake Williams, 2020. "Is the devil in the shadow? The effect of institutional quality on income," Review of Development Economics, Wiley Blackwell, vol. 24(4), pages 1463-1483, November.
    • Handle: RePEc:bla:rdevec:v:24:y:2020:i:4:p:1463-1483
    DOI: 10.1111/rode.12691
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    Cited by:

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    2. Ozer, Yusuf, 2022. "Informal Sector and Institutions," MPRA Paper 114755, University Library of Munich, Germany.
    3. Estevão, João & Lopes, José Dias & Penela, Daniela, 2022. "The importance of the business environment for the informal economy: Evidence from the Doing Business ranking," Technological Forecasting and Social Change, Elsevier, vol. 174(C).
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