Economic Recession, Informal Sector and Skilled–Unskilled Wage Disparity in a Developing Economy: A Trade-Theoretical Analysis

Date01 May 2020
Published date01 May 2020
Subject MatterArticles
Economic Recession,
Informal Sector and
Wage Disparity in a
Developing Economy:
A Trade-Theoretical
Sushobhan Mahata1, Rohan Kanti Khan1 and
Ranjanendra Narayan Nag2
The paper analyses some selective aspects of economic crises, namely skilled-
sector recession, reversed international migration of labour and decline in foreign
capital inflow on the informal sector employment and wage rate in developing
economies and seeks to explain the non-monotonic effect on the informal sector
both across nations and within nation across sectors. In so doing, we develop
three-sector General Equilibrium models under two different scenarios which
may apply to a large class of emerging market economies. In the first model, we
have a traded informal export sector, and the role of the non-traded informal
sector in the presence of credit market imperfection is analysed in the sec-
ond model. Skilled-sector recession produces a favourable (unfavourable) effect
on the workers employed in the traded informal sector (non-traded informal
sector) due to an induced complementary relationship between the high-skilled
export sector and the informal sector. A fall in emigration level of skilled or
unskilled worker and a decline in foreign capital inflow hurt the workers in the
informal traded sector, while the workers in the non-traded informal sector
gain. The results of the paper reflect contradictions of an emerging economy,
which is essentially hybrid economics in which capitalist nucleus has a conditional-
conditioning relationship with an archaic structure.
1 Department of Economics, University of Calcutta, Kolkata, India.
2 Department of Economics, St. Xavier’s College (Autonomous), Kolkata, India.
Corresponding author:
Sushobhan Mahata, Department of Economics, University of Calcutta, Trinath Building, Flat No-T26,
Narayantala West, Baguiati, Kolkata 700059, India.
Foreign Trade Review
55(2) 168–188, 2020
© 2020 Indian Institute of
Foreign Trade
Reprints and permissions:
DOI: 10.1177/0015732519894132
Mahata et al. 169
JEL Codes: F13, J31
Credit market imperfection, informal sector, economic recession, wage inequality
An economic crisis that passes through an extended phase of recession affects not
only the traded sector in the developing and Emerging Market Economies (EMEs)
but also severely affects the non-traded (domestic) sector in those nations. The
impact of such crises on these developing nations varied widely depending on the
magnitude of trade openness and its shock absorption capacity that usually
depends on the size of the informal sector in those economies. Some of the severe
financial crisis that turned into recession, such as the Asian Financial Crisis 1997
and the Global Financial Crisis 2007–2008, had affected the developing econo-
mies mainly through three primary channels, that is, through a decline in global
trade volume thus hurting the exports of the developing nations, variation in for-
eign capital flow, reduced access to credit and reversed international migration
flow of labour.
Trade was one of the major channels that transmitted the crisis to the developing
nations. A sharp fall in the demand for imports in the advanced economies caused
shrinking of the world trade volume. Exports of developing nations were
significantly hurt. It was evident from the effects of the financial crisis of 2008
that affected China’s export which fell sharply from about 20–25 per cent in just
a few months (Dullien, Kotte, Márquez, & Priewe, 2010). Along with trade, the
financial crisis also caused the reverse flow of foreign private capital from the
EMEs and other developing nations. During the Global Financial Crisis 2008, net
capital inflows fell from US $108 billion in 2007–2008 to US $ 9.1 billion in
2008–2009 in India, that was mainly due to an increased risk aversion among the
investors1. Foreign Direct Investment (FDI) flow to Africa declined by about 36
per cent in 2009, specifically the cross-border mergers & acquisitions (M&As)
declined by about 73 per cent during 2008–2009. It was estimated that flow of
foreign investment to emerging economies will contract by more than 30 per cent
in 2009; for instance, it was estimated that FDI inflow to Cambodia would fall to
US $390 million (Huynh, Kapsos, Kim, & Sziraczki, 2010). This lowered the
access to credit by private investors in the developing countries that continued till
the end of 2009. The contraction in international bank lending had led to the total
net inflow of US $400 billion in 2007 turned to a net outflow of more than the
US $80 billion in 2009 from the EMEs. Makun (2017) tested the effect of financial
crisis for the Malaysian economy using dummy variable corresponding to 1997-
Asian financial crisis and 2008-global financial crisis and obtained that export
and investment declined significantly in late 2008, which restricted the GDP
growth rate in Malaysia. Lower availability of formal credit leads to an increase
in the cost of obtaining credit by private investors, thus further depressing the

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