Capacity Utilization, Income Distribution, and the Urban Informal Sector: An Open-Economy Model

Abstract

Developing economies worldwide have experienced rapid informal sector expansion in response to formal sector unemployment. However, the macroeconomic effects of formal-informal sector dualism have been widely overlooked. This paper develops a two-sector, structuralist, macroeconomic model to analyze the impact of urban informal sector activity on export-led growth policy. The model uses stylized facts from the Johannesburg informal sector and is applicable to countries where informal sector production is concentrated in low-wage goods and commercial services. The paper finds that trade-offs between capacity utilization and reduced income inequality could be magnified when the existence of an urban informal sector is incorporated.

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