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Exploring the relationship between productive structure and the informal economy: evidence from Latin American countries

Abstract:

Purpose: The purpose of this study is to examine the relationship between the productive structure and the size of the informal economy in Latin American countries. Design/methodology/approach: The study employs econometric techniques for panel data covering the period from 2002 to 2017 and considering 17 Latin American countries. The evidence presented is based on the informal economy data generated by Medina and Schneider (2018) who estimate the size of the informal economy using a structural equation model and the share of manufacturing in total employment as a measure of the size of the manufacturing sector. Also, the study addresses the possible endogeneity bias in the relationship studied and makes the conclusions more robust, thus avoiding spurious correlations that weaken the findings. Findings: The results indicate that most industrialized Latin American countries are associated with a smaller size of the informal economy. Practical implications: The findings have important policy implications, as they suggest that Latin American economies need to switch the structure of the economy toward more sophisticated productive structures if they want to reduce the size of the informal economy. Thus, more efforts should be deployed to policies to diversify and upgrade economies. Originality/value: The study contributes to the literature on the informal economy by connecting the country’s productive structure and informality. Specifically, the results show that the productive structure of countries is a plausible explanation for the size of the informal economy.