FORMALIZING THE INFORMAL PROBLEM AND PROSPECTS OF STATE PATRONAGE

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FORMALIZING THE INFORMALPROBLEM AND PROSPECTS OF
STATE PATRONAGE

• Sugata Marjit
• Centre for Studies in Social Sciences,Calcutta
• July,2009

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Consider the following problem faced by a
firm.  
Formal Informal w1 gt
w2 t,tax rate applicable in the formal sector.
Transaction cost of using informal
labour Punishment costs,Contract
enforcement costs,quality maintenance etc.

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L
O
A
B
C
If market size is small, P is low.
Only informal hiring OA
If P is big part formal,part
informal(BC,OB).
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P decreases for low quality,increase high
quality(assumption)2 firmsP1gtP2 or Capital
stock of 1gtcapital stock of 2. Safety net for
workers State support for OAOB no. of
workers.But identification implies governance
costs.Firms may perceive a rise in harassment
after formal identification may mean lowering
of OA and OB - cost of Formalization. If firms
have to provide for the safety net,a direct
increase of w2 as well,reduction in OA,OB.
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Safety net for firms

• Interest subsidy/Formal sector loan
• Changed F.O.C (Operating capital)
• r1ltr2 (formal interest ltinformal interest)
• Again,reducing r2 will raise Informal
  Employment-in fact for bigger firms greater
  incentive to informalize.For smaller firms
  increase in may offset any rise in employment.

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Policy Solutions

• More investment everywhere so that (Pf) shifts
  up increasing employment.
• Minimize bureaucratic verification and harassment
  so that does not increase much.
• Reduce t simultaneously.
• Core Problem
• Informal thrives because it does not need to
  have formal identity.Will it go for
  formalization?Natural conversion is through
  economic growth.