Macroeconomics

Linguistics

Philosophy

Materials science

Enforcement

Formality

Aggregate (composite)

Economics

Market economy

Computer science

Total factor productivity

Political science

Public economics

Macro

Productivity

Welfare

Unemployment

Composite material

Programming language

Margin (machine learning)

General equilibrium theory

Machine learning

Annual Review of Economics

This article reviews the economic literature on informality, its causes, and its consequences for development. It covers a comprehensive body of research that ranges from well-identified experimental studies to equilibrium macro models, and which more recently includes structural models that integrate both micro and macro effects. The results available in the literature indicate that lowering the costs of formality is not an effective policy to reduce informality but may generate positive aggregate effects, such as higher output and total factor productivity (TFP). The most effective formalization policy is to increase enforcement on the extensive margin but not on the intensive margin of informality. The former generates substantial gains in aggregate TFP and output, without necessarily increasing unemployment. However, the overall welfare impacts are likely to depend on the transitional dynamics between steady states, which remains an open area for future research.

Informality: Causes and Consequences for Development