Services Growth: Productivity, Formalization, Redistribution or Exports? A Developing Economy, Segmented Markets Model

Abstract

This study attempts to understand the growth of services & informal sector’s capital formation, by modelling the formal-informal sector value chain in an economy with goods, asset and labour market segmentation. It considers a developing economy with a large informal sector and splits the services’ production into high-end & low-end services, produced in the formal & informal sectors respectively. It contributes by modelling low-end services (produced in the informal sector with consumer durables as capital) as inputs for internationally traded high-end services and monitors the impact of productivity shocks, and policy changes on services’ growth & the informal sector’s capital formation, income and consumption. Simulation results show that formalization of an economy and manufacturing’s productivity improvement have the largest impact on services’ growth and informal sector’s capital formation. Similarly, redistribution of incomes from the formal to informal households or higher exports of internationally traded services, benefit the services sector but have lower elasticities. Productivity improvements in sectors producing non-traded goods/services have no overall impact except price adjustments of that non-traded output.