The informal economy and economic volatility

Abstract

The informal economy has traditionally played an important role in most Caribbean economies. Indeed, small-family-owned plots supplied a considerable domestic demand for agricultural commodities. Most Caribbean economies are now primarily service-oriented; however, the informal sector still plays a major role in most of their economies. There are disadvantages to an over reliance on the informal sector: low-tax yields and a focus mainly on the domestic market. This paper argues, nonetheless, that the informal sector is a key mechanism for insulating households from the effects of large negative economic shocks. The study therefore investigates the effects of the size of the informal economy on economic volatility in the Caribbean with emphasis on consumption volatility. The results are not meant to argue for policies to support the growth and penetration of the informal sector, but instead for policies aimed at supporting entrepreneurship within the region.

Keywords:

• informal economy
• economic volatility
• crises
• Caribbean

JEL classification:

• E26
• E32
• D9

Notes

1. To quantify how much of the GDP in the world is informal, Schneider, Buehn, and Montenegro (2010) weighted by total country GDP. More precisely, for every country/year, they weighted the rate of informality by the total GDP. This provides the GDP in current billion US dollars that is informal for each country/year. Then this amount is summed and divided by the total GDP of the sample.

2. Non-stationarity in time series procedures gives rise to least squares or maximum likelihood estimators that are no longer normally distributed.

3. As pointed out by one referee, it should be noted that measurement of consumption volatility used in this paper implies that part of the explainable consumption volatility is offset by the income volatility. The approach was, however, employed as the study attempts to investigate if the informal sector can assist with consumption smoothing. If this is the case, one would expect a reduction in unexpected fluctuations in the average propensity to consume (Abeysinghe and Choy 2004).

4. The Breusch–Pagan statistic for cross-sectional dependence was 66.566[0.103], suggesting that the null of cross-sectional independence could not be rejected at normal levels of testing.

5. Other thresholds were considered, but this did not change the findings reported in the study appreciably.

Additional information

Notes on contributors

Winston Moore

Terral Mapp is currently an economist in the Ministry of Finance and Economic Planning in St. Vincent and the Grenadines. He has previously researched issues related to the responsiveness and stability of tax systems in Small Island developing states in the Caribbean. He holds a B.Sc. in Economics and Accounting (Honours) from the University of the West Indies, Cave Hill Campus.

Winston Moore is a senior lecturer in the Department of Economics of the University of the West Indies, Cave Hill Campus. Prior to this, he was also a senior economist at the Central Bank of Barbados. His main research interests are related to the development challenges facing small states, particularly those in the Caribbean. He holds a Ph.D. in Economics from the University of Surrey, an M.Sc. in Economics from the University of Warwick and a B.Sc. in Economics from the University of the West Indies, Cave Hill Campus.