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Economic Reform, Informal-formal Sector Linkages And Intervention In The Informal Sector In Developing Countries: A Paradox

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Executive Summary

Within a general equilibrium framework of a developing economy with a foreign owned factor of production, this paper questions whether the informal-formal sector relationship is procyclical / complementary - expansion or contraction in one necessarily implies an expansion or contraction in the other - when the informal sector is subject to a technological shock. The authors derive a necessary and sufficient condition under which a positive shock to the informal sector results in a contraction in both the size of the urban formal sector and the informal sector.

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