Trade liberalization, production organization and informal sector of the developing countries

Abstract

The paper provides an explanation of recent empirical evidence on fragmentation and the expansion of the informal sector in India. We argue that as the prospect of getting a better price in the international market increases, the producers in the formal sector act more like merchants and subcontract production activities to the producers in the informal sectors. Expanding production in the informal sector allows the firm to take advantage of a growing export market. Our theoretical model explains such organizational change in terms of allocation of monitoring effort between marketing and production. The existence of a low-wage informal sector facilitates division of labor and specialization in the formal segment.

Keywords:

• informal sector
• trade liberalization
• subcontracting
• occupational specialization

JEL Classification:

• E26
• F12
• F16

Acknowledgment

The authors are indebted to an anonymous referee for helpful comments and editorial assistance. The usual disclaimer applies.

Notes

1. The detailed calculations are available from the authors on request.