DP16498 Growing Apart or Moving Together? Synchronization of Informal and Formal Economy Cycles

Author(s): Ceyhun Elgin, Ayhan Kose, Franziska Ohnsorge, Shu Yu
Publication Date: August 2021
Keyword(s): Business cycle, Informal economy, Self-employment
JEL(s): E26, E32, J46, O17
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16498

We study the degree of synchronization between formal- and informal-economy business cycles. Using a comprehensive database of informal activity that covers a wide range of informality measures from almost 160 countries over the 1990-2018 period, we report two major results. First, fluctuations in informal-sector output are strongly positively correlated with those in formal-sector output. In contrast, fluctuations in informal employment are largely uncorrelated with those in formal-sector output. Second, movements in the formal economy tend to spillover to the informal economy. Using a novel set of instrumental variables, we show that fluctuations in formal-sector output "cause" movements in informal-sector output.