Essays on the economics of the informal sector in India

Abstract

As of 2011-12, informal workers in India accounted for 85.8 percent of the labor force, while the informal sector contributed nearly 55 percent to the GDP. This dissertation presents three essays on the economics of the informal sector in India. In Chapter 2, I use Indian labor market data to test whether workers are able to self-select into formal and informal employment. I find no evidence of workers being able to self-select into formal employment. Thus, workers may face entry barriers that restrict them from entering formal employment and they choose informal employment as a last resort. In Chapter 3, we use firm-level data on formal and informal production in the manufacturing sector in India to examine the sectoral consequences of government investment in public infrastructure. The average output elasticity of the flow of public investment for an informal sector firm is 3 times smaller than its formal counterpart. For the accumulated stock of public capital, this difference increases to a factor of 7. In Chapter 4, I set up a two-sector endogenous growth model incorporating the informal sector to examine the implications of efficiency of public capital on the optimal tax rate, and on the optimal allocation of tax revenues toward maintenance of public capital. Results show that in presence of the informal sector, the growth-maximizing tax rate in the decentralized economy is lower, and the welfare-maximizing optimal share of maintenance expenditure is shown to be positively related to the informal to formal output ratio.