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GTAP Resource #1248

"Heterogeneous Agents, Inequality, and the Informal Sector in Developing Countries: A Dynamic General Equilibrium Analysis"
by Saracoglu, Durdane Sirin

In recent years, there has been an increased interest in studying the informal sector as an important characteristic of less-developed and developing countries. In particular, this interest has focused on the relationship between the quality of institutions and the relative size of the informal sector in developing countries (Friedman et al. 2000, and Djankov et al. 2001). In the economics literature, institutions are in part defined by property rights and contractual agreements. In any economy, capital and land asset markets are said to be “relatively institutionally intensive” in the sense that agent behavior in these markets is dependent on institutional arrangements more than in any other market. Hence, initial institutional arrangements, and institutional rigidities in capital and land markets may lead to permanent asset and income inequality among various economic groups.

This paper elaborates on the relationship between the degree of inequality and the evolution of the informal manufacturing sector vis-à-vis the evolution of agricultural and the formal sectors in a stylized, developing country economy in the process of economic growth. The analytical framework used in the analysis is a dynamic general equilibrium, multi-sector Ramsey-type growth model with three factors of production (land, labor and capital), three production sectors (agricultural, formal manufacturing and informal manufacturing), and two groups of households. Land is fixed and specific to agricultural sector, whereas labor and capital move freely between the three sectors. The stylized economy is an open economy with two internationally traded goods (agricultural and formal manufacturing goods) and a non-traded good (informal manufacturing good). The manufacturing sectors are differentiated in terms of the type of the goods produced, and the factor elasticities of production. The two groups of households are differentiated such that there are asset-wealthy households who own all capital and land in the economy in addition to their own labor, and asset-poor households who have no access to capital and land markets, and only earn wage-income. The asset-wealthy households also have access to the means of savings and the economy accumulates capital over time. Another key feature of the model is that non-homothetic preferences of Stone-Geary form are introduced to reproduce the Engel effects in consumption of agricultural and informal manufacturing goods.

To test the model against actual data, the model is calibrated to Turkish National data for the year 1997 (Statistical Yearbook of Turkey, 1998) and solved for the transition to the steady-state equilibrium using the time-elimination method by Mulligan and Sala-i-Martin (1991). The simulated results of the model show that given any degree of asset and income inequality, the shares of agricultural output and informal manufacturing output in GDP diminish with the process of growth. By contrast, the share of formal manufacturing output increases with growth. Additionally, a positive relationship between the degree of asset and income inequality and the size of the informal sector is established. It is also shown that a high degree of asset and income inequality is associated with low capital accumulation and low growth in per capita GDP. The simulation results also yield insights into the changes in the sectoral allocation of factors of production (labor and capital) with the process of growth.

The results of this paper suggest that the initial differences in institutional arrangements as proxied by the degree of income and asset inequality may account for the historically different experiences in economic growth and development in countries such as those in East Asia, and those in Latin America and Africa.

Resource Details (Export Citation) GTAP Keywords
Category: 2003 Conference Paper
Status: Published
By/In: Presented at the 6th Annual Conference on Global Economic Analysis, The Hague, The Netherlands
Date: 2003
Created: Saracoglu, D. (4/29/2003)
Updated: Bacou, M. (4/30/2003)
Visits: 3,138
- Economic development
- Dynamic modeling

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