Informal stall business, income inequality, and welfare in a dual economy

Abstract

We consider an emerging economy with a dual production structure, exemplified by China, and examine the income distribution and welfare effects of supporting and expanding the urban informal sector. In the short run, with a given number of urban manufacturing firms, a land-rent policy for supporting the informal sector narrows the wage inequality between skilled and unskilled labor, but in the long run the policy can widen the skilled-unskilled wage gap due to the free entry of manufacturing firms into the urban industrial sector. Conversely, the land-supply policy yields the opposite effects by increasing the wage gap in the short run while the gap is reducing in the long run with firm exit in the urban industrial sector. The analysis is extended to the scenario that skilled labor is interested in migrating to the informal sector. The policy implications of corporate social responsibility (CSR) applicable to both informal stall business and formal business can be deduced accordingly.