To be or not to be informal?: A Structural Simulation

By José P. Mauricio Vargas

The paper presents estimations of the informal economy size in Bolivia from an application of a Dynamic General Equilibrium Model. The parameter estimation is performed using maximum likelihood method to obtain, as an intermediate result, a latent variable estimation of the informal economy size. This procedure is new, as the estimate of the size of the informal economy using a dynamic structural model represents an alternative study area to latent variable models which assume relationships without a strong support in theory (MIMIC models). The results suggest that the size of the informal economy represents 60% of Bolivian GDP in 2010 and that the trend has been decreasing in the last decade. In addition, we simulated four alternative policies to reduce the size of the underground economy. Some of them allow to identify surprising response mechanisms which allows to analyze the flow of workers from the informal sector into the formal sector and vice versa. The research, besides quantifying the informal economy size, tries to provide a tool and methodology for evaluating alternative policy scenarios related to fiscal policy and labor mobility in a framework of an economy with a large informal sector and evasion.

This paper is a very interesting application of a structure DSGE model to measure a phenomenon that is otherwise very difficult to evaluate: the informal economy, which is not measured by definition. Drawing a model that geberates a informal sector and then estimating it with observable data can lead to interesting results that should be more reliable than traditional methods which, for example, rely solely on money or electricity demand.

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