The Economics of the Informal Sector: New Estimates, New Implications for OECD countries

This paper explores the dynamics and implications of the informal sector within OECD countries, employing a novel estimation approach based on an endogenous growth model. The model integrates both formal and informal sectors, incorporating public services and key determinants of informality. By calibrating this model with OECD data from 1996 to 2016, we derive significant insights into the size and impact of the informal sector. Our findings reveal that, on average, the informal sector constitutes 19.98% of the economy. Policy adjustments influencing the informal sector exhibit a nonlinear effect on economic growth. Specifically, increased formal sector taxation, reduced penalties on informal activities, enhanced access to public goods, and improved quality of government institutions all dynamically interact to shape the informal sector's size and its economic consequences. This study underscores the necessity of a nuanced policy approach, considering the structural characteristics of the economy to optimize growth while managing informality effectively.