Informal sector and the developing world: relating theory and evidence to India

The informal economy has emerged as one of the most dynamic and active segments of the entire developing world. Contemporary studies show that markets and competition both play dominant roles in determining wages in the informal sector. One major theme that we shall discuss deals with how the wage and employment in the informal sector responds to shocks to which formal or organized/unionized segment of individual industry types are subject to. We use simple general equilibrium expositions to answer this critical question and substantiate that with evidence from India. The generalized theory is also supported by other empirical evidences from Africa and Latin America. We mainly argue that without capital accumulation in this sector – an outcome of capital mobility between the formal and informal sectors, the observed upward wage movement or productivity growth in the informal sector would not have been possible. Empirically, growth in informal fixed assets imparts positive and significant impact on the urban informal wage in India. The emergence of informal sectors and the close connection with corruption are also discussed in detail.