Formal-Informal Economy Linkages and Unemployment in South Africa

by DAVIES, R. & THURLOW, J., 2009
Research Report, Employment Growth & Development Initiative, Human Sciences Research Council

South Africa’s high involuntary unemployment and small informal sector are attributed to an underperforming formal sector and barriers to entry into the informal sector. Davies and Thurlow examine the economy-wide linkages between the formal and informal economies, while accounting for different types of informal activities. A multi-region, empirically calibrated computable general equilibrium (CGE) model is developed, capturing both product and labour markets. Three policy options are considered. The results indicate first that trade liberalisation reduces national employment. However, it increases formal employment, hurts informal producers, and favours informal traders, who benefit from lower import prices. Second, wage subsidies for low-skilled formal workers boost national employment, but hurt informal producers by increasing competition. Third, unconditional cash transfers stimulate demand for informally produced products, thereby raising informal employment without undermining formal producers. Overall, these findings underline the importance of distinguishing between the implications of socio-economic policies for the formal and the informal sectors.