### Paper Menu >>

### Journal Menu >>

Modern Economy, 2011, 2, 39-44 doi:10.4236/me.2011.21006 Published Online February 2011 (http://www.SciRP.org/journal/me) Copyright © 2011 SciRes. ME Informal Wage, Informal Price and Extortion under Migration and Tariff Reform* Biswajit Mandal1, Saswat i Chaudhu ri2 1Visva-Bharati University, Santiniketan, India 2St. Xavier’s College, Kolkata, India E-mail: biswajiteco@gmail.com, biswajit.mandal@visva-bharati.ac.in Received January 9, 2011; revised January 20, 2011; accepted February 4, 2011 Abstract In this paper we propose a theoretical model where formal and informal sectors co-exist in tandem. Trade union segregates some labor from being formal. Capital is not allowed to freely move between formal and informal sectors. Using this sort of framework it has been shown that immigration of unskilled workers re- duces the return to informal labor and makes the informal good relatively cheap. A tariff slash also impinges on similar kind of results. In both the cases informal capitalists gain. Moreover, what is more striking is that both migration and tariff reform are equally bad for the economy as a whole since these policies enhance the ‘unproductive’ element or labor in the society which is really costly as these laborers could have been used to produce some more consumable commodities. Keywords: International Trade, Corruption/Extortion, Informal Sector, Migration, General Equilibrium 1. Introduction Irrespective of the type of countries, be it developing or developed, the existence of informal sector is an undeni- able fact of real world. Informal sector mainly consists of non-agricultural sector or any sector which is not regis- tered and not legal, per se. In fact more than 50% in South Asia, 30-50% in South East Asia, almost 50% in Africa, 55% in Latin America and Caribbean, 24% in Southern Europe, 10% in Western Europe, 18% in Can- ada and 8% in USA employment come under the infor- mal purview ([1-3]). Here we define informal sector by the non-existence of trade union implying a perfectly competitive labor market for unskilled informal workers. Since informal sector is unlawful, it is beset with inter- mediation related extortion1. At this point extortion is defined by the set activities of a group of people who intermediate with local governmental authority for the survival of informal units. In return of this intermediation extortionists get a wage equivalent to the wage of infor- mal workers. Hence informal production and extortion are complementary with each other in a sense. Another important facet of factual world is migration. It could be immigration of unskilled workers or emigra- tion of skilled workers. The reasons might be a search for better job opportunity (pull factor) or relatively poverty- stricken native land (push factor). The issue of interna- tional migration posits itself in causing major challenges to the socio-economic condition of a country. For exam- ple, India has a long history of receiving a constant in- flow of migrants from Bangladesh. More than 56% of the migrants to India are from Bangladesh. Though the trend of Bangladeshi immigrants has decreased in recent times, the absolute number is still huge and warrants discussion. These migrants generally find work as cheap labor in the informal sector of the receiving country. Coupled with these issues trade protectionist policies are gradually taking the backseat. Continuing demolition of tariff has become the prime agendum of all economies across the globe. Therefore, in this paper we will try to look at the possible effects of all these policies in a trade theoretic framework described in the next section. We primarily focus on three things: informal wage, price of the informal good and extortion activity due to immigra- tion and tariff reform. Several papers have been written in this line [8-14]. In a recent volume [15] emphasize has been given on different facets of informal sector and dealt with varied intricate issues. But none of the papers *The authors like to thank the editor of this journal and two anonymous referees for many insightful comments. However, the usual disclaimer applies. 1Interested readers may look into [4,5,6,7] etc. for further understand- in g of extortion and informal activi t ies. B. MANDAL ET AL. Copyright © 2011 SciRes. ME 40 in the existing literature has attempted to focus on the effects of migration on informal wage, informal price, extortion etc. The next section describes the model and provides with the solution. Section 3 analyses the effects of mi- gration and reform. Section 4 points to some possible extensions which is followed by concluding remarks in Section 5. However, relevant mathematical details are relegated to the Appendix. 2. The Basic Model and Solutions Here we have a small open economy producing three goods: X, Y and Z. Out of these three goods X (export- able) and Y (importable) are traded but Z is a non-traded one. Hence x P and y P are determined in the interna- tional market whereas z P is determined by the standard Cobb-Douglas demand function. X and Y use skilled la- bor (S) and unskilled labor (L) respectively as specific factors but they share a common capital (K). Note that Y is protected by a tariff and L is unionized there. Thus L gets W as wage in Y. Therefore X and Y constitute the formal segment of the economy. However, Y is not capa- ble of absorbing all unskilled workers. Hence some “unlucky” workers have to search for an alternative op- tion and they find it in the informal sector (Z) where wage rate is determined by the competitive pressure. Z uses T as a specific factor. As informal sector is distorted by the intermediation of local ‘tolapickers’ (n L) a certain proportion ( ) of the value of the good ( z P) is appro- priated by n L as the fee of extortion. Informal produc- ers have to abide by this ‘system’ as informal units are illegal by rules. We can easily term this extortion activity as ‘corruption’ sector if we go by Bhagwati’s [16] con- cept of directly unproductive profit seeking activities (DUP). Since n L workers get the same wage as infor- mal workers total expenditure on n L (= w. n L) has to be equal with the lost value of output (= z P. Z). We further assume competitive market for all goods and fac- tors. Production of goods follows constant returns to scale (CRS) and factors of production exhibit diminish- ing marginal productivity (DMP). Following Jones [17,18] we can describe the model by the following symbols and the set of equations, where, j P price of the jth commodity (j = X, Y, Z); S W skilled wage; W unskilled formal wage; W unskilled informal wage; r rate of return to K; R rate of return to T; ij a production re- quirement of the ith factor in one unit of jth commodity ( i = S, L, K, T and j = X, Y, Z); S total supply of skilled labor; L total supply of unskilled labor; n L number of unskilled labor employed in extortion; K total supply of capital, K; T total supply of capital, T. The competitive price conditions are given by: SSXKX x Wa raP (1) 1 LYKY y Wa raPt (2) 1 LZTZ z Wa RaP (3) 2 Note that ww because of the trade union exercise in the formal unskilled segment. Full employment of all the factors guarantee the following equations, . SX aXS (4) .. KX KY aXaYK (5) .. L YLZ n aYaZ LL (6) . TZ aZT (7) Let us further assume that the demand for Z follows standard Cobb-Douglas preference where fraction of consumers’ income is spent on the informal good. This is denoted by .1. 1. xy z PX tPYPZ (8) The value-cost equality of extortion is .. . z PZ wLn (9) Here we have nine unknown variables (, , , S WWr , , , , and z n RPX Y ZL)and nine equations. For given t and y P, we solve r from (2). Given x P, we solve S W from (1).The technological co-efficients for X and Y are determined from the CRS assumption. X can be derived from (4) for any given S. Equation (5) solves the value of Y for given K and for the given value of X, calculated from (4). Again for any given and positive n L, we get the value of Z from (6). Consequently z P is solved from (8). W and R are determined from (3) and (7). Moreover, we can solve for equilibrium n L from (9). So the system is solved. For a detailed technique one can check [19,20]. 3. Effects of Migration and Reform 3.1. Immigration of Unskilled Workers An immigration of unskilled workers indicates an in- crease in labor supply in Z. This is likely to influence the output of Z, W and n L. However as x P and y P are given, there would be no change in S W, r and .W Through CRS assumption output of X and Y would not change. This implies a constant .1 . xy P XtPY for given t. Hence demand for Z remains same and z P cru- cially depends on supply of Z. 2 implies the degree of extortion and 01. B. MANDAL ET AL. Copyright © 2011 SciRes. ME 41 An increase in L immediately pushes W down and for given Z (and hence unchanged z P) R must go up. Pro- ducers will try to economize on the usage of T. This en- sures an increase in the supply of Z from Equation (7). For given , z P if Z goes up n L must increase from (9) (also see Figure 1) again as Z rises and .1 . xy PX tPY remains same z P must fall be- cause is constant. When W falls, Wn L rotates down. But as L increases some more L would also be employed as extortionists and productive L in the informal sector will increase as well. Thus .. z PZ would shift up. These two effects would result in an unambiguous increase in n L. By simple mathematical manipulation and using the standard notation we can arrive at the following expres- sions (see Appendix for detailed calculation). 1 ˆˆˆ ˆ0, ˆˆ ˆ as 0 xkx xy sxty ky xy tt XPPt PPt (10) Note that throughout the paper ‘Λ’ represents proportional change. i = elastcity of substitution in ith commodity. ij = value share of ith factor in jth commodity. ij = quantity share of ith factor in jth commodity. 1ˆ ˆˆˆ 0 kxx kx xy ky sxtyky tt YPPt (11) ln 1(1) ˆˆˆˆ 0 nz lzzlztz lztz RLLP (12) For given z P, ˆ0R as ˆ L can not be less than ln ˆn L . Note that even if entire increased L is absorbed in extortion, ln ˆˆ n LL as ln 01. ln (1 ) ˆˆˆˆ () 0 tz nz lzzlztz lztz WLLP (13) α P z Z O L n L n L ' n αP z Z (αP z Z)' (WL n )' WL n Figure 1. Change in the number of extortionists due to immigration. ln ˆˆˆ 0 lz n lz tz ZLL (14) From (8) 0 (as ˆˆ ˆˆ () )0 z PZ XY (15) From (9) ˆˆˆˆ ˆ z n PZWL Or, as ˆˆ ˆˆ ˆ ()0 and ()0 nz WL PZ (16) Or, 0 as ˆˆ () 0 ˆn LW W (17) Thus the following proposition is immediate: Proposition I: An immigration of unskilled labor a) Depresses the informal wage, b) Expands the informal output, c) Decreases the price of the informal good, and d) Enhances the number of extortionists. 3.2. Tariff Reform A reduction in tariff in the protected sector (Y) changes the return of K as formal wage is already fixed at .W The return to capital r will fall in both X and Y. But as x P is given S W must go up leading to an increase in X and a fall in Y as these two goods share the same mobile capital, K. The moment Y falls some unskilled labor would be released from Y and would rush to Z to raise the output of Z. In this process the informal wage rate must fall as the supply of unskilled workers go up in the informal sector. If we assume an unchanged .1 ., x yz PXtPY P should decline as Z has already increased. A similar diagram like Figure 1 helps ex- plaining the effect on n L which must increase. Mathematically the effects of a tariff cut can be sum- marized as follows: ˆ ˆˆˆ 0, aˆ s 0 and 0 xkx xy sx ky tt XPPt (18) ˆ ˆˆˆ 0, as 0 and 0 ˆ kxx kx xy ky sxky tt t YPP (19) ˆ0 ˆ ky t rt (20) ˆˆ kx S ky sx tt W (21) . ln . 1 ˆ.0 . ˆ ˆlykxkx n lz zlztzkykysx RLtt (22) R will increase for a given Ln and we prove later that ˆ0 n L, in that case ˆ R is not unambiguously positive. B. MANDAL ET AL. Copyright © 2011 SciRes. ME 42 We need to put some more restrictions. . . ˆ(). 0 . ˆ ly kx tz kx lzz lzlztzkykysx tWt (23) ˆˆˆ .( )0 lz x ZRW (24) If there is no change in .1 .,.. xyz PXtPY PZ would also remain unaltered. Hence from (9) 0 as ˆˆ ˆ () 0 n LW W (25) And from ˆˆ () 0 z PZ (26) However, if .1 . xy PX tPY does not remain unaltered ˆ ˆˆ .( ) kx kx z yx sx ky tPZ t (27) Where .. . x x z PX PZ and .. . y y z PY PZ If x y and kx ky (likely to hold true). z P must fall as Z has already increased. But for kx ky the impact on z P is uncertain. This leads to the follwoing proposition: Prposition II: Due to trade reform informal workers are worsened but informal output gets a boost. However the number of extortionists must go up. 4. Some Possible Extensions 4.1. Capital Mobility If capital is allowed to move among X, Y and Z an immi- gration of L would not depress W (for given z P) like the basic model. Because, r would not change (from Equa- tion (2)) and it would be same for all the sectors. Hence out put of Z will increase and that of Y would fall if lz ly following Rybczynski argument. However, when lz ly , Z would, in fact, contract. Depending upon the output effect on Z, z P will change. Note that if , lz ly .1 . xy PX tPY would fall as Y falls. Thus z P must decrease as Z has already risen. And again .. z PZ should fall as .1 . xy PX tPY has fallen. We already know that W has not changed, there- fore the effect on n L is certain and it would fall. 4.2. Skilled Emigration If skilled workers emigrate, there will be a tendency for S W to rise. But since the system determines r from (2) and it is unchanged, S W can not change because of small country assumption. Therefore production of X would fall due to shortage of specific skilled labor. Sub- sequently, some capital would be released from X to augment production of Y. Again in order to produce more Y some more unskilled workers need to be relin- quished from Z. This will induce an increase in W and hence a fall in R for given P. As R falls, TZ a should increase and subsequently Z will fall. If we assume .1 . xy PX tPY as constant even- tually z P would go up. Thus from equation (9) n L has to fall as .. z PZ remains same through the constancy of .1 . xy PX tPY . Thus an outmigration of skilled workers is good for the society as a whole as n L falls and is also good for informal workers in particular as W goes up. 4.3. Foreign Capital Inflow If foreign capital comes in the formal sector there will be changes in the outputs but r, W and S W would re- main unchanged because of the structure of the model. Both X and Y would increase. X would expand more than Y if distributive share of capital is higher in X than that of in Y. In order to produce more X, skilled labor need to be substituted by increased capital as supply of skilled labor is fixed at S. However, as far as an increase in Y is con- cerned, along with increased capital the necessity of an increased employment of unskilled workers is also there. These workers should come from informal sector and hence W will rise. At given z P, R has to fall. This will induce a reduction Z. From (8) the Left Hand Side (LHS) has gone up and Z falls, therefore, subsequently z P must increase. It should be noted that the effect on n L is uncertain. 5. Conclusions Here we have built a trade theoretic model where both formal and informal sectors are embedded. Informal sector is segregated from the formal world by the non-existence of trade union. Since informal units are illegal, they are distorted by extortion. In this framework we have shown that both the immigration of unskilled workers and a tariff cut lead to similar kind of results. Under these two situations informal workers lose, infor- mal output expands but informal capitalists gain. But what is more worrying is that under both these cases number of extortionists in the economy inflates. If we allow for capital mobility between formal and informal sectors, this would not matter much for the informal workers under immigration of unskilled workers and reform. Nevertheless, an outmigration of skilled workers would raise the informal wage and reduce the number of B. MANDAL ET AL. Copyright © 2011 SciRes. ME 43 extortionists. Informal wage would also go up if we al- low foreign capital to come in. We can easily invoke some other possibilities in this set up. One is when the demand for informal good comes only from formal unskilled sector. Under immigration of unskilled workers, the wage rate of informal labor must fall and there would also be a decline in the informal commodity price. This assumption is quite sensible in that skilled workers constitute the richer section of the society and they do not usually consume informal goods. The interesting point is that it does not matter whether the richer segment of the society demands the informal good, the effect of immigration of unskilled workers on informal wage, price and extortion are identical. Another interesting possibility is the introduction of new imported substitutes of Z which, essentially, move away the de- mand for Z. This may happen in the post reform period (if we assume the existence of prohibitive tariff in the pre-reform phase). In this situation, consequent upon reform, the price of the informal good would fall by a relatively large amount. The size of the extortion sector would increase in this case also. Nevertheless, the extent of increase would be relatively less. 6. References [1] B. R. Dijkstra, “Good and Bad Equilibria with Informal Sector,” University of Nottingham, School of Economics, Discussion paper 06/01, 2006. [2] M. Drakard, “Corruption and Bribery as a Way of Life in Africa,” The Cutting Age, 26 October, 2009. [3] K. Gerxhani, “The Informal Sector in Developed and Less Developed Countries: A Literature Survey,” Public Choice, Vol. 120, No. 3-4, 2004, pp. 267-300. doi:10.1023/B:PUCH.0000044287.88147.5e [4] P. S. Amaral and E. Quintin, “A Competitive Model of the Informal Sector,” Journal of Monetary Economics, Vol. 53, No. 3, 2006, pp. 1541-1553. doi:10.1016/j.jmoneco.2005.07.016 [5] K. A. Konrad and S. Skaperdas, “Extortion,” Economica, Vol. 65, No. 260, 1998, pp. 461-477. doi:10.1111/1468-0335.00141 [6] S. Skaperdas, “Cooperation, Conflict and Power in the Absence of Property Rights,” American Economic Re- view, Vol. 82, No. 4, 1992, pp. 720-739. [7] S. Skaperdas and S. Constantinos, “The Distribution of Income in the Presence of Appropriative Activities,” Economica, Vol. 64, No. 253, 1997, pp. 101-117. doi:10.1111/1468-0335.641066 [8] H. Beladi and C. Chao, “Non-Traded Goods, Urban Un- employment and Welfare in LDCs,” European Journal of Political Economy, Vol. 9, No. 2, 1993, pp. 281-292. doi:10.1016/0176-2680(93)90023-N [9] H. Beladi and S. Marjit, “Foreign Capital and Protection- ism,” Canadian Journal of Economics, Canadian Eco- nomics Association, Vol. 25, No. 1, 1992, pp. 233-38. [10] S. Chaudhuri, “How and How Far to Liberalize a Devel- oping Economy with Informal Sector and Factor Market Distortions,” Journal of International Trade and Eco- nomic Development, Vol. 12, No. 4, 2003, pp. 403-428. doi:10.1080/0963819032000154829 [11] R. W. Jones, and S. Marjit, “Competitive Trade Models and Real World Features,” Economic Theory, Vol. 41, No. 1, 2009, pp. 163-174. doi:10.1007/s00199-008-0394-0 [12] S. Kar and S. Marjit, “Urban Informal Sector and Pov- erty,” International Review of Economics and Finance, Vol. 18, No. 4, 2009, pp. 631-642. doi:10.1016/j.iref.2008.06.009 [13] B. Mandal and S. Marjit, “Extortion and Informal Sector in a Small Open Economy,” MPRA paper No. 25044. http://mpra.ub.uni-muenchen.de/25044/, 2010. [14] S. Marjit, “Economic Reform and Informal Wage: A General Equilibrium Analysis,” Journal of Development Economics, Vol. 72, No. 1, 2003, pp. 371-378. doi:10.1016/S0304-3878(03)00082-8 [15] S. Chaudhuri and U. Mukhopadhyay, “Revisiting the Inf- ormal Sector-A General Equilibrium Analysis,” Springer, 2010. [16] J. Bhagwati, “Directly Unproductive Profit Seeking (DU- P) Activities,” Journal of Political Economy, Vol. 90, No. 5, 1982, pp. 988-1002. doi:10.1086/261104 [17] R. W. Jones, “The Structure of Simple General Equilib- rium Models,” Journal of Political Economy, Vol. 73, 1965, pp. 557-572. doi:10.1086/259084 [18] R. W. Jones, “A Three-Factor Model in Theory, Trade And History,” In: J. Bhagwati, et al., Eds, Trade, Balance of Payments and Growth, North- Holland, 1971, pp. 3-21. [19] S. Marjit and B. Mandal, “Corruption and Trade in Gen- eral Equilibrium,” Globalization and Economic Policy at the University of Nottingham, UK: Research paper No. 2008/15, 2008. [20] S. Marjit, S. Chaudhuri and S. Kar, “Recession in the Skilled Sector and Implications for Informal Wage,” MP- RA paper No. 18003. http://mpra.ub.uni-muenchen. de/- 18003/, 2009. B. MANDAL ET AL. Copyright © 2011 SciRes. ME 44 Appendix Differentiating Equation (2) one gets, ˆˆ ˆ1 ky y rPttt (A.1) Differentiating (1) and substituting (A.1) into that, ˆˆ 1ˆ ˆkx kx Ssxx y ky ky WPPt tt (A.2) Differentiating equation (3) ˆˆˆ ˆ 1 lztz z WRP (A.3) Given that the factor endowments remain constant, from the full employment conditions we get, ˆˆSX X a (A.4) ˆˆ 0 kx ky XY (A.5) ln ˆˆ ˆ ly lzn YZL (A.6) ˆˆTZ Z a (A.7) Using the concept of elasticity of substitution in X and the zero profit condition we have ˆ ˆˆ SXXSkx arW (A.8) where, ˆˆ ˆ ˆ SX KX x S aa rW Using the above equation one can easily calcultae that 1 ˆˆ ˆ ˆ xkx xy s xtyky tt XPPt (A.9) ˆˆ 1 ˆˆ kxx kx xy ky sxtyky t tt YPP (A.10) ln 1 ˆˆ ˆ 1 ˆˆ ˆ tz z lztzlz lzz ly kx kxkx n kykyky sx WP LL tt (A.11) Substituting (A.10) in (A.6) and then using (A.3) we have, ln ˆˆ ˆˆ ly lzkx kx n lz tzkykysx Z LL tt (A.12) From equation (8) ˆˆ .ˆ kx kx zyx sx ky PttZ (A.13) where .. . x Px X Pz Z and .. . y Py Y Pz Z And again from (9) ˆˆˆˆ ˆ nz LPZW (A.14) We can use the above equations to find out the specific effects of migration and tariff cut on informal wage, informal price and extortion. |