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Environmental Regulation in the Presence of an Informal Sector

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  • Soham Baksi
  • Pinaki Bose

Abstract

We analyze the efficacy of environmental regulation in the presence of an endogenous informal sector. Firms in an imperfectly competitive formal sector produce a final good using a polluting intermediate good. The firms can either produce the intermediate good or purchase it from a price-taking informal sector. An environmental regulator sets the emission intensity of the intermediate good that all formal sector firms implement honestly but informal sector firms seek, and are sometimes able, to evade. We show that, depending on the stringency of the regulation and its enforcement, the informal sector can act as a source of pollution leakage. Stricter regulation can increase (when the “composition effect” of regulation dominates its “scale effect”) or decrease total pollution, and may even have a non-monotonic impact. Further, price discrimination by the formal sector, when it purchases the intermediate good from the informal sector, can worsen regulatory compliance by the informal sector and lead to lower welfare.

Suggested Citation

  • Soham Baksi & Pinaki Bose, 2010. "Environmental Regulation in the Presence of an Informal Sector," Departmental Working Papers 2010-03, The University of Winnipeg, Department of Economics.
    • Handle: RePEc:win:winwop:2010-03
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    References listed on IDEAS

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    1. Chaudhuri, Tamal Datta, 1989. "A theoretical analysis of the informal sector," World Development, Elsevier, vol. 17(3), pages 351-355, March.
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    More about this item

    JEL classification:

    • Q56 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law

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