The Role of Complementarities, IRS and Multiple Equilibria in the Process of Economic Development

In 1970’s the world of economic thought experienced a re-emergence of neoclassical economics that has traditionally been pre-occupied with laissez-faire. Given such obsession, neoclassicals posited that the application of standard microeconomic principles in the third world context would tackle the issue of underdevelopment as it (i.e. underdevelopment) is born out of lack of markets due to weak or non-existent property rights.  In this essay, with the help of QWERTY example, I want to argue that even if one comes from a neoclassical perspective, still there will exist market failure that may require some form of state intervention; and in the LDCs, underdevelopment will be the result of such massive coordination failures. In particular, under neoclassical assumptions, the issues of complementarities and increasing returns to scale will lead to the existence of multiple equilibria where only one is pareto-efficient; in the presence of multiple equilibria, issues such as path dependency and history will force the economy to get stuck with pareto-suboptimal equilibrium.    

                                                Figure source: Growth Dynamics, Multiple Equilibria, and Local                                                            Indeterminacy in an Endogenous Growth Model of Money, Banking and                                                 Inflation Targeting by Rangan Gupta and Philton Makena

The types of externalities can broadly be categorized into technological and pecuniary ones. While market can capture technological externalities (i.e. due to such externalities market might be in disequilibrium), pecuniary externalities are not captured in the General Equilibrium framework. Pecuniary externality occur when the profit of one producer is affected by the actions of other producers through market prices; in other words, pecuniary externality arises when the price of one good in an economy depends on the prices of other goods in the economy: 

where P is the price at which the first firm sales its products. 

Pecuniary externality leads to market imperfection and complementarities that will in turn, along with the assumption of increasing returns to scale (IRS), will lead to the existence of multiple equilibrium. Let’s consider To-Become-Tea-Lovers country. Suppose that two firms, T and S exist in this economy: while T produces tea, S produces sugar; suppose that due to some changes in the taste of people living in this economy, the demand for tea increases and as a result T expands. This will result in increase in the demand for S’ product; so, S will expand. This in turn will have a positive impact on the demand for T’s products because now with more income available from the expansion of S, demand for tea further increase. These two firms will keep reinforcing each other’s profit. Thus, a monopolistic economy will be shaped: imperfect market. This way, pecuniary externality leads to imperfection in the market. Let’s note that in such a scenario, the First Fundamental Theorem of Welfare Economics stands in the way because it rules out Pareto-ranked equilibria in the absence of technological externalities.

Now, to show that complementarities and IRS lead to the existence of multiple equilibria, let’s consider QWERTY example. Dvorak Simplified Keyboard (DSK), according to experiments, is more efficient arrangement compared to QWERTY, and it is said that typing with DSK is 20 to 40% faster compared to QWERTY. However, we are still stuck with the later due to 3 issues, namely (1) technical interrelatedness, (2) economies of scale, and (3) quasi-irreversibility of investment.

Technical inter-relatedness refers to the interdependence that exists between typewriters and typing skill. In the past, when typewriters were invented, it was purchased by businesses for business use. The purchaser wouldn’t himself/herself use the machine, rather it was used by typists who were trained in typing schools. This gives rise to some form of inter-relatedness; the business will buy those types of machines for which typist (soft skill) can be found; on the other hand, the typist would try to learn typing with those types of machine that are available with businesses. Thus, a form of complementarity is formed.

In this situation, when a firm buys a QWERTY-keyboard typewriter, this signals a positive pecuniary externality to those typists who are skilled in typing with QWERTY-keyboard. Also, the demand for QWERTY-keyboard learning will go up which will result in the reduction of average cost of learning QWERTY-keyboard due to economies of scale (IRS). Thus, complementarity and economies of scale create QWERTY path-dependency, meaning the purchase of a QWERTY-keyboard by a firm and subsequence choice of learning this QWERTY-keyboard skill by potential learners will finally lead to dominance of QWERTY-keyboard. However, if the issue of quasi-irreversibility of investment did not exist, it would have been possible, even now, to go to DSK.

Quasi-irreversibility of investment refers to rise of asymmetry that rose between the cost of hardware and software conversion in mid-1890s. In mid-1890’s, the possibility to move back and forth between QWERTY-keyboards and DSKs without any extra cost was made possible but the cost of learning DSK was going up because the demand for QWERTY-keyboard learning was rising. This is called Quasi-irreversibility of investment.

In this example, we see that pecuniary externalities, complementarities, increasing returns to scale, history and path dependency and quasi-irreversibility of investment have led to multiple equilibria, being caught up in low level equilibrium and market failure. In other words, if someone, say government coordinated the actions of business owners and labor force at the initial stage, pareto-optimal equilibrium would have been achieved. Based on this example, we can argue that even coming from a pure neoclassical perspective, market failure can happen and there is a need for coordinated action to help the economy achieve a pareto-efficient equilibrium. In the LDCs, underdevelopment can be a result of massive coordination failures do to the issues of complementarities and increasing returns to scale.  We can also show the existence of multiple equilibria, coordination failure and the need for some form of intervention to coordinate actions by considering an economy where left to themselves, firms may not invest because they might expect that other firms will not invest.

Informal Sector; Composition and Linkages

When the notion of informal economy was first established, influential economists like Arthur Lewis (1954) believed that informal sector would slowly fade away as development happens and finally, when development riches a certain maturity level, the informal economy will completely disappear. History, however, signals rather the opposite of what Lewis and others wished for: formal and informal economies are highly interlinked, and now the dualist narrative seems somewhat irrelevant. This short article discusses the composition of informal sector. It also looks into the prospects of growth for different components of the sector.

Researches show that the informal sector is very heterogenous. In this sector, you can find businesses that do not employ any machinery and laborers work complete their work manually. Some of the businesses have only one worker who is working for subsistence and employ no employees, while some other informal business may employ several workers and some primitive or even a few sophisticated tech machines.

Ranis and Stewart (1999) made a distinction between the traditional and modern parts of informal sector. Figure 1 shows the distribution of informal business along a modernity continuum based on a number of characteristics.

Traditional informal businesses are at the very bottom of the continuum. They employ no hired worker, no or a very low level of capital, have extremely low or no capital usage and make no use of hired labor. As to their location, they operate within the premises of a household or do not have a fixed location, and the type of activities they engage in are very low value-added activities. when we move upwards along the continuum, at the very top of the distribution, we have informal businesses that use some capital, produce standardized goods and services, hire low- and medium-skilled labor, have a fixed address outside the household and offer competitive wages that are comparable with the wages offered in the formal sector. However, what make them informal is the fact that they do not comply with all the rules and regulations imposed by government and other legal entities on the formal sector.

The above discussion of informal sector composition is based on making a distinction between traditional and modern sectors of informal economy. Though, Nattrass (1987) approaches the composition of informal sector from a very different perspective. He bases his theoretical analysis on a triangle, composed of 3 sub-triangles, where parts of industrial reserve army, marginal pole and formal sector make up the components of informal sector (see Figure 2). The main argument in this perspective is that only some part of the marginal pole fits into the informal sector, that the industrial reserve army may or may not participate in informal activities, and that people who are not marginalized can also form part of the informal sector.

The triangle of industrial reserve army has two sub-parts a and b. The people who are seeking full time jobs in the formal sector and are living, probably on savings or borrowing from relatives and friends, constitute sub-part a. They are not part of the informal sector because they are not doing any productive economic activity, and therefore they are excluded from the inner circle of the diagram. Sub-component b consists of those people who have temporally joined the informal sector but theoretically speaking, they could get a job in the formal sector. These people will immediately leave the informal sector when a job is available for them in the formal sector. 

The marginal pole triangle consists of people who have no formal sector skills or experience.  A section of these people (see d in Figure 2) probably works for low wages in the informal sector. Component e consists of the truly marginalized people who are not even employed in informal sector.

The other triangle is formal sector triangle which includes people working in the formal sector full-time (see f in Figure 2); but at the same time, some of them have jobs in the informal sector to supplement their income (see c in Figure 2).

In the framework that Nattrass has drawn, formal and informal sectors are negatively correlated, because most of whose who are working for informal sector are also looking for jobs or are capable of getting jobs in the formal sector. This means expansionary activities in formal sector pull labor force from the informal sector; but a recession will push many to the informal sector. In different terms, when formal sector expands, informal sector will shrink and vice versa. In this sense, informal sector is a necessary appendage to a capitalist economy that cannot full fill its obligations optimally, and thus leaves a part of its duty to the informal sector. In other words, informal sector is born out of a necessity that stem from faulty function of capitalism. Faulty function in the sense that its labor market cannot employ everyone in the formal sector; so, it produces an appendage such as informal sector to tackle the issue of unemployment and underemployment to some degree. However, note that the benefit of formal sector expansion will be extremely small for marginal pole, but significant for industrial reserve army and formal sector workers who complement their income with earnings from informal sector.

Some economists, like Stark, see informal and formal sectors as complements for each other. They argue that the two sectors depend on each other. The formal sector produces some of its goods in informal market, for the informal sector’s labor is much cheaper. Take the RMG sector for example. This conception of relationship between formal and informal sectors, again, sees informal sector as a byproduct of capitalism, but not because it cannot function optimally, rather because the existence of informal sector is profitable to capitalism.

Some other economists, such as Datta Choudhury, propose inverse linkages between formal and informal sectors. In Datta Choudhury’s model, formal sector produces Xu and Mu while the informal sector produces Mz. We see that M is produced competitively in both sectors. That why M is produced in both sectors is because some businesses do not or cannot choose to enter formal sector due to constraints, legal obligations and the extra costs that the formal sector imposes on them. In the formal sector, the cost of labor is very high, while in the informal sector, the cost of credit is extremely high; but, because the two sectors compete on M, they cannot set their prices higher than market prices. This model suggests that in some products, formal and informal sector have inverse relationship. Lower prices, better productivity and improved technology in the formal sector might reduce the sight of informal sector. Conversely, hike in cost of production of M in formal sector may increase the size of informal sector.

Suppose the government steps in and provides credit support to the informal sector, and bring down credit costs substantially. In such a situation, because informal sector becomes more profitable, the formal sector businesses will seek ways to join informal sector to reduce their labor costs and reap the benefits of low wages in the informal sector. However, the credit costs in the informal sector are very high that government intervention cannot produce any remarkable result. Thus, in the developing world, informal sector cannot graduate to formal sector because of persistently high costs of credit.

As to the relation of informal sector with growth, the existing literature indicate forward production links for modern informal firms with formal firms. It can be shown that growth and competitiveness in the formal sector benefits the modern informal sector. Competition within formal sector leads formal businesses establish links with the informal sector and this will expand activities in the informal sector.

In the consumer market, traditional informal firms survive operate in a different market segment than formal firms, and thus they do not pose a direct threat to the formal sector. But, modern informal firms may grow to the level that they can compete with formal firms. This will pose a threat to the size and growth of formal firms. Informal firms are advantaged over formal SMEs because they have lower start-up and operational costs. When it comes to size expansion, informal businesses are at disadvantage because they cannot expand beyond certain size even if their profitability permits it. Thus, from the consumer market perspective, the size and growth of informal firms will also depend on the regulatory framework.

Ranis and Stewart (1999) argue that the demand for products from the informal sector depends, among other things, on the level of per capita income and its distribution. A low per capita income means income inequality is high and thus a larger part of people will demand goods and services provided by traditional informal firms. This means the traditional informal sector will grow when income per capita is low or when income inequality is high. But, when income increases or when income distribution improves, more and more people will demand goods and services produced by the modern informal sector. This implies that modern informal sector will grow if income increases or when income inequality declines.

References:

LEWIS, W. A. (1954). Economic Development with Unlimited Supplies of Labour. The Manchester School, 22(2), 139–191. doi:10.1111/j.1467-9957.1954.tb00021.x 

Nattrass, N. J. (1987). Street trading in Transkei—a struggle against poverty, persecution, and prosecution. World Development, 15(7), 861–875.

Ranis, G., & Stewart, F. (1999). V‐Goods and the Role of the Urban Informal Sector in Development. Economic Development and Cultural Change, 47(2), 259–288. doi:10.1086/452401 

The Link b/w Productivity and Size in the New Economic Geography Angle and in the Standard Agglomeration Literature

When people and firms live side by side in cities and industrial areas, some benefits come to exist out of this coexistence. These benefits are studied under the title of agglomeration economies. In this writing, I will try to figure out the difference between New Economic Geography angle and standard agglomeration literature in suggesting that productivity and size may be directly associated. Also, I will try to interpret rank size rule when applied to city size distribution in a country. 

The agglomeration literature built on the studies of Henderson (1974) and Sveikauskas (1975) posits that firms in large cities are more productive. This increased productivity comes from the indivisibilities in investment, huge infrastructure base, large market size, lower labour turn-over cost, and easy information-sharing that exist in large cities. Combes et al. (2012) furthers the literature by offering two main explanations for the average increased productivity of firms in larger cities. The first explanation involves firm selection that means competition among firms are tough in larger cities and this allows only the most productive to survive. The second explanation involves agglomeration economies which is possibly reinforced by localized natural primacy. The New Economic Geography (NEG) literature, too, discusses the impact of agglomeration on economic growth. According to this strand of literature, migration and population expansion in cities are motivated by the trade-off between increasing returns and mobility costs. According to Krugman (1991), employees and companies become more productive due to the existence of external-scale economies. What makes the New Economic Geography angle different from standard literature produced by urban economists is the level of their analysis: NEG literature analyses the impact of city size or agglomeration on economic growth at the national level while standard agglomeration looks into the impact of city size on the productivity of urban workers at the city level.

Now, let's see the interpretation of the rank size rule when applied to city size distribution in a country. Zipf’s rank size rule suggests that the largest city is roughly twice the size of the second largest city, about three times the size of the third largest city, and so on. This relationship can also be understood and explained as inverted u-shaped relationship between city size and productivity/growth, meaning that initially as city increases in size, productivity of the firms in that city increase. This continues up to a certain point beyond which growth decreases as city increases. The decrease in productivity beyond the threshold limit in the city size would mean that firms will need to look for fresh urban setting in other places in order to make new investment. In the same way, new migrants may not find it worthwhile to migrate to the cities which have already reached an optimum size. 

To sum up, the New Economic Geography angle analyses the impact of city size or agglomeration on economic growth at the national level while the standard agglomeration looks into the impact of city size on the productivity of urban workers at the city level. And, Zipf’s rank size rule can be understood and explained as inverted u-shaped relationship between city size and productivity/growth, meaning that initially as city increases in size, productivity of the firms in that city increase. This continues up to a certain point beyond which growth decreases as city increases. The decrease in productivity beyond the threshold limit in the city size would mean that firms will need to look for fresh urban setting in other places in order to make new investment.

References: 

Henderson, J. (1974). The Sizes and Types of Cities. The American Economic Review, 64(4), 640-656. Retrieved March 27, 2021, from http://www.jstor.org/stable/1813316 

Leo Sveikauskas, 1975. "The Productivity of Cities," The Quarterly Journal of Economics, Oxford University Press, vol. 89(3), pages 393-413. 

Combes, P., Duranton, G., Gobillon, L., Puga, D., & Roux, S. (2012). The Productivity Advantages of Large Cities: Distinguishing Agglomeration From Firm Selection. Econometrica, 80 (6), 2543-2594. http://dx.doi.org/10.3982/ECTA8442 

Krugman, Paul, 1991. "Increasing Returns and Economic Geography," Journal of Political Economy, University of Chicago Press, vol. 99(3), pages 483-499, June.

The Causes of Rural-to-Urban Migration

Rural to urban migration refers to the movement of people from rural areas into cities and often involves migration of labour and change of carrier. This type of migration is caused by different push and pull factors. In this article, I will discuss the causes in the view of both theoretical as well as empirical literature. Also, I will examine the literature to see whether or not the low income households are better-off in large cities compared to their counterparts in small urban settlements.

Different theories have discussed different determinants and aspects for rural-urban migration. One of the early theories of rural-urban migration belongs to John R. Harris and Michael Todaro. According to Harris-Todaro (1970) model, rural-urban expected income differentials is the most important factor that determines rural to urban migration. While urban labourers/employees receive industrial wages, rural workers earn agricultural wage. In a developing country setting, assuming that the Lewisian turning point has not been reached, there will exist a significant wage differential between the two sectors, i.e. agricultural and industrial sectors. Thus, the model postulates that the rural workers will migrate to urban areas in order to receive a higher wage. The model implies that the rural poor will have a higher propensity to migrate given that their income is almost zero in the rural areas. However, some empirical results have shown just the opposite: propensity to migrate has been lower among the disadvantaged classes of rural areas.

Harris-Todaro model also considers another important determinant of rural-urban migration: distance. As the model suggests, larger the distance, lower will be the migration from rural to urban settings because the cost of migration goes up. This agrees with theories which suggest that, as cities are expanding their boundaries and more and more agricultural lands from rural areas are reallocated towards uses other than agriculture, the rural areas at the outskirts of cities get connected to cities through transport infrastructures; thus, the people of the rural areas near the cities need not migrate to cities. They can participate in economic activities in the cities without migration. Harris-Todaro model also suggests that rural-urban migration also depends on the extent of poverty in the two areas. If the extent of poverty in rural areas is very high, there will be high propensity to migrate to urban areas. Conversely, if the extent of poverty in the urban area is high, then there will be low propensity for rural-urban migration.

While Harris-Todaro model proposes that, due to high wage differentials, the rural poor has a higher propensity to migrate, Banerjee’s theory suggests that the poor cannot afford to migrate. According to him, the rural rich do not need to migrate, the rural poor cannot afford to migrate; so, it is the rural middle income who migrate to urban areas either for earning higher income or for accessing better healthcare, education and other public service facilities. Thus, Banerjee’s theory posits that the level of income is an important determinant of rural-urban migration.

In addition to the above, there are other theories such as Job-search, role of network, altruism versus principle of exchange etc. all of which suggest that migrants, before departing to urban areas, collect a great deal of information regarding their destinations.

From a historical and empirical point of view, we can list some more determinants for rural-urban migration. Net expected return, social norms, skills and education, literacy, gender-based demand, marriage, institutions and the concentration of pools of migrants are some of these factor. Families may send their young adults to urban areas because they are more likely to have a positive net expected return on migration since they are expected to have longer remaining life expectancy. In some societies, social norms determine who should migrate in search of job and higher earning. For example, in Afghanistan, it is usually not welcomed by the society to send a woman to urban areas alone for job purposes. In case of institutions, if strong property rights exist that can ensure safety of once property after migration, then such property rights might encourage rural to urban migration; or, when access to credit market is not possible for migrants in urban settings, this institutional issue might deter rural-urban migration. As an example of concentration of pools of migrants let me point out to the migration of Hazaras of Jaghori district of Afghanistan to Quetta, Pakistan and Sydney, Australia.

In addition to the above factors, one can list a set of push and pull factors (determinants). Push factors are generally tied to the poor economic conditions of household in the rural areas who migrate to urban settings in order to alleviate their poverty. For example, individuals who are unemployment, underemployment in rural areas, earn very low wages and lack assets and land, migrate to urban areas to improve their conditions. Other push factors can be lack of rural infrastructure such as housing, education and healthcare. However, push factors can include forced displacement such as conflicts and climate change. Pull factors refer to relatively better opportunities in the urban areas compared to rural areas. In other words, pull factors are those which attract migrants from rural settings to urban areas.

As to whether or not the low income households are better-off in large cities compared to their counterparts in small urban settlements, literature suggests that low income households are better off in large urban centers as they provide better job opportunities in relative sense. According to the literature, the living conditions in the informal sector is better than what the migrants accessed at the place of origin.

Reference: 

Harris, J., & Todaro, M. (1970). Migration, Unemployment and Development: A Two-Sector Analysis. The American Economic Review, 60(1), 126-142. Retrieved March 27, 2021, from http://www.jstor.org/stable/1807860

The Critical Role of Middle Class in Corruption in South Asia - A Reflection on Mushtaq Khan's Paper

Introduction

In the paper of Patron-Client Networks and the Economic Effects of Corruption in Asia, Mushtaq Khan traces the political influence of the Indian subcontinent’s middle class in their leading role in the anti-colonial struggles and argues that in the post-colonial era, the class has played its part in corruption through a transaction channel that I would like to term it “bribe-for-support”. This view is not far from realities and in the present days, if not all, a part of the body of middle class is playing an active role in state corruption by justifying unethical, illegal or extra-legal and unjust policies of the politicians and state.

                        

          Source: Illegal Wildlife Trade at the Philippine-Southeast Asian Nexus: An Assessment of                    Projects combating Illegal Wildlife Trade in Southeast Asia informing the Philippines and 

          guiding Donor Coordination by Cecilia Fischer

Who are the middle class?

Khan defines the middle class as “the educated sections of the population” who are non-capitalists, non-politicians, non-peasants and surely not landlords[1]. Hence, their main asset using which they can make a living is their intellect. This class can employ the asset either to serve high humane values such as expansion of justice, promoting equality, peace and freedom, or, conversely, succumb to the lures of money, power, or position and engage in justifying/turning a blind eye on unjust and illegal policies and corrupt practices. Khan’s argument implies that the middle class has chosen to succumb instead of resisting. 

The class played a critical role in the subcontinent’s political corruption 

As Khan observes, the politicians understand the importance of the middle class’ support who can mobilize the masses against the ruling class. In the aftereffect of demise of colonialism, the class was much stronger and a real threat to the ruling class. Hence, to have its support, the government would bribe the class in different ways – distribution of cheap land and heavy investment in higher education that was then entirely serving the middle class are two examples of such bribes[2].

Following Khan, I am of the opinion that the middle class has continuously betrayed high ethical and humane values and at high times, it has surrendered to the temptation triangle: money, power and position. The funds saved from spending on running election campaigns paves the ground for bribing the middle class. However, the members of this class have never pushed for electoral financing reforms that shall target banning capitalists from funding candidates’ campaigns which opens the doors for their intervention in state agendas. It is mostly the members of this class that pickup their pens and write to justify the corrupt practices of the politicians during election campaign in order to get a position in the post-election government.

Its role in corruption might have increased. With the increase of power of states and capitalists in recent decades, the influence and importance of middle class has relatively shrunk; this, I believe, might have increased the role of the class in corrupt practices. When relatively powerful, the class can better resist the pressure of different forms from the state and politicians to side with their unjust and illegal policies and practices. A weaker middle class, though, is much more prone to the influence of state and politicians. This means, the body of intellectuals are now more prone to accept corrupt practices of the state, support and justify them out of inability to resist. This is a very obvious fact in the context of Afghanistan. In the four presidential elections that have taken place in Afghanistan in the post-Taliban epoch, it has been the members of the middle class at the forefront of justification of the dark and tyrant past of the politicians. Afghanistan has been repeatedly ranked as one of the most corrupt states in the past twenty years. The interesting point is that most politicians and bureaucrats are coming from the middle class.

Summary

To sum up, concurring with Khan, I believe that the middle class has given in to the fascination of power, money and official government posts. This unethical behavior has helped state and administrative corruption to take roots and grow overtime. It is very famous among the political scientists that in the absence of constant criticism and oversight of intellectuals, power corrupts those who own it. The middle class – defined as the educated section of a society – bears an ethical obligation to oversight power, critique it for the purpose of reform and take active part in the produce, reproduction and distribution of knowledge. I am of the view that in the developing countries, the said section of the society, by siding with the politicians and the ruling class, has failed to fulfill its obligations. One can even argue that a part of, if not the whole, middle class, i.e. the intellectuals, has remained as corruption-justifying instrument in the hands of politicians and rulers in the Indian subcontinent and in the Central Asian and Middle East countries.

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[1] Khan, M. Patron—Client Networks and the Economic Effects of Corruption in Asia. Eur J Dev Res 10, 15–39 (1998). https://doi.org/10.1080/09578819808426700

[2] Khan, M. Patron—Client Networks and the Economic Effects of Corruption in Asia. Eur J Dev Res 10, 15–39 (1998). https://doi.org/10.1080/09578819808426700

Exploring the Benefits of Formalization Drive for Informal Firms in a Developing Country Setting

Introduction

Informal sector constitutes a large part of a developing economy. It seems that the informal firms take a rational decision to exit from the formal domain by comparing the costs and benefits of formalization. (Suresh De Mel, David McKenzie, and Christopher Woodruff, 2013). De Mel and others found that formalization has a very limited impact on the profitability of the firms who exit the informal sector and join the formal one. Given this, we want to find out if the push for formalization of informal firms in a developing country is of any benefit. Here, I want to argue that any push for formalization in the developing countries will act as a double-edged sword. In other words, it is an act that has both favorable and unfavorable consequences. Still, I believe that the favorable consequences of formalization outweigh its unfordable outcomes.

The unfavorable consequences of formalization drive

Government might waste its budget on firms that cannot stand in the competing world of formal sector. Firms which are in the informal sector can easily compete with formal sector firms and even have an edge over them due to lower wages, non-existence of taxes and other types of costs that are related to activity in the formal sector. In the informal sector, they can survive even if they do not make a profit. This is what makes activity in the informal sector favorable to informal firms.

The firms that can survive in the informal sector might not survive once they enter the formal sector unless there is enough financial support from the government. If we assume that the government will support them with subsidies, then there will not be much room to argue that formalization is good because it adds to the income of the government. If subsidies or financial amounts are paid to induce informal firms to become formal, then one would argue that letting informal firms in the informal sector is better because they will not be a burden on the budget of the government. If we argue that incentives should be paid only for a short time, then one would counter us that the firms might return to the informal sector as soon as the government cut its financial support. Therefore, we can say that one unfavorable consequence of push for formalization through financial incentives is that government might waste its budget on firms that cannot stand in the competing world of formal sector.

A large section of people might not be able to survive. Another somewhat obvious consequence of push for formalization is that a lot of firms might completely die out and disappear after a while when they enter the formal sector without any financial support from the government. Of course, here we are assuming that the government is using force to turn the informal sector formal. This means that a large part of people who could previously survive working in the informal sector now even might not be able to survive.

The favorable consequences of formalization drive

Tax and efficient allocation of resources

Research has shown that informality and lower tax collection are related – a phenomenon that reduces the ability of the government to finance public services (Levy, 2008). Hence, one favorable consequence of formalization is higher tax collection that will enable the government to better finance public services and even invest in the development projects. However, taking our discussions in the previous paragraph into consideration, we should cautiously optimistic about this consequence of formalization.

The coexistence of formal and informal firms leads to an inefficient allocation of resources in the economy through the different marginal production costs (Chang-Tai Hsieh and Peter J. Klenow, 2009). Therefore, formalization will lead to efficient allocation of resources which is another favorable consequence.

Profitability for the firms and contribution to economic growth and development

In addition to the above, another favorable consequence of formalization is access to formal business infrastructure including credit, technological support and access to more markets which ultimately lead to higher productivity and output of the firms. This favorable consequence can be viewed from the perspective of firms, because firms which are active in the informal sector have no or very limited access to what we just pointed out. Similarly, the firms will no longer be subject to harassments and bullying of government authorities asking for bribes.

We said that formalization opens access to formal business infrastructure including credit, technological support and access to more markets which ultimately lead to higher productivity and output of the firms. Higher productivity means, for the firm, higher profits and for the entire economy higher growth. Through this channel, formalization helps an economy with its growth and development.

Impacts on the quality of life of laborers

Apart from the above, I believe formalization will have positive impacts on the quality of life of labor force. When informal firms are formalized, they are required to follow labor laws set by relevant authorities. Wages of laborers will increase and some form of protection will be provided to employees/laborers. This is while in the informal sector, firm owner is restricted by no law and he/she can set any wages and can hire/fire on the spot. Of course the problems that informal sector laborers are facing are not limited to wage and instant firing. Inhumane working conditions are another big issue.

Conclusion and my take 

As discussed above, in the case of financially incentivizing informal firms to join the formal sector, the government might waste its budget on firms that cannot stand in the competing world of formal sector. However, there are chances that the firms stand on their own feet and become competitive profit-maximizing firms. If governments, backed by the use of force, coerce informal firms to go formal, there is a risk that a large section of people might not be able to survive when the informal sector disappears. This is firstly impossible. Even if we assume its possibility, due to inefficient and ineffective outcomes, it is not recommended.

Apart from the above undesired possible outcomes under certain conditions, I believe that formalization drive for informal firms in a developing country setting has various benefits. It can improve the quality of life of laborers employed by the informal sector, it can make survivalist firms profit-maximizing which contribute to the economic growth and development, it can improve the allocation of resources throughout the economy, and finally it adds to the income of the government. Hence, as stated at the opening paragraph of this writing, I believe the favorable consequences of formalization outweigh its unfordable outcomes.

References

Chang-Tai Hsieh and Peter J. Klenow. (2009). Misallocation and Manufacturing TFP In China and India . Quarterly Jouranl of Economics.

Levy, S. (2008). Good Intentions, Bad Outcomes: Social Policy, Informality and Economic Growth in Mexico. Brookings Institution Press.

Suresh De Mel, David McKenzie, and Christopher Woodruff. (2013). The Demand for, and Consequences of, Formalization among Informal Firms in Sri Lanka. American Economic Journal: Applied Economics.

What Could Be an Ideal Relationship Between Religion and Law?

Introduction

Religion and law can be related to each other in different forms. It can be the main source where rules and regulations emanate. Religion can be a sub – but still, a major - source of legislation, or the legal system of a country can be completely independent of religion. We might be able to identify other forms of relations, too. But, for our purpose, the above categorization suffices. And what one might define as an ideal relationship between the two can vary based on his/her general world view. One can view the world from the lens of religion, secularism, or any other lens that he or she might deem appropriate. In this writing, I want to base my analysis of the ideal relationship between religion and law on ethical grounds. In other words, I want to use some tools of ethics to reach some conclusions: I assume that “violation of the rights of minorities or the minorities being deprived of their basic human rights is ethically unjustified”. By making this assumption, I am clarifying what the word ideal means to me: ethically justified.

Base on the above assumption and with the help of examples from South Asian legal systems, as well as examples from legal systems in some of the middle east states, I want to I argue that complete independence of the legal system from religion is what I see as an ideal relationship between the two. In order for me to reach such a conclusion, I should first be able to show that any other possible relationship between religion and law can be deemed not ideal on ethical grounds.

Religion as the main and only source of legislation

Religion can be the main source of rules and regulations. An extreme example of this sort of relationship between law and religion can be found in Afghanistan if we go back two decades in history. The Islamic Emirate of the Taliban implemented its own fundamental interpretation of Sharia and it was the only and the main source of any rules and regulations. Under the Sharia rule of the Taliban regime, no kind of rights was reserved for other minority groups. Basic freedoms, such as freedom of thought, freedom of speech, and freedom of religion did not exist as they were thought to be non-religious or anti-religion. Even Muslim minorities such as Shia Muslims were deprived of their basic religious rights. If we move out of the South Asian context, we can find Saudi Arabia where the legal system is tightly married to religion, and again minorities are deprived of their various rights. The state is accused of violation of human rights that it carries out on the basis of religion. Using a political interpretation of Sharia, the Saudi government is oppressing its political opponents and dissidents. From these two examples, we see that once religion dominates legal systems, then there will be violations of human rights for groups that are considered as minorities, and people will be deprived of some rights they would otherwise have. On this basis, I reject such systems as unethical.

Religion as one – but influential - source of legislation

A second form of the relation between religion and law can be that religion is considered one of the several sources of legislation. In Islamic countries where there is some form of democracy and where a functioning parliament exists, religion is not the sole source of legislation. A big portion of rules come from parliament that is not religious in nature, although they are not and cannot be against religious principles, either. The current legal systems installed in Afghanistan, Pakistan, Iran and Iraq are of this nature. This form of the relationship once again is problematic when it comes to the issue of human rights and the rights of the minority groups. Freedom of thought, freedom of speech and freedom of religion are clearly violated in such systems, as thoughts that are thought to be against principles of religion cannot be expressed and groups that are religious minorities are facing bulks of discriminations which are legal. In March 2006, an Afghan citizen who converted into Christianity was facing death penalty under the legal system of Afghanistan, but with the pressure of international donors on the government of Kabul, he was released. He had to leave Afghanistan and reside in a European country because of the lack of freedom of religion under Afghanistan’s legal system. In Iran the followers of Baháʼí Faith are facing huge legal discriminations. The Iranian regime does not show any mercy against its dissidents and beside national security, religious rules are exploited to sue its opponents. Hence, this type of relationship between the two produces unethical results and therefore cannot be deemed ideal.

Legal Systems Independent of Religion

Legal systems can be independent of religion. We may not be wrong if we call such systems secular legal systems. In political setups where the religious sphere is distinguished from the government sphere, and where state does not intervene in religious affairs, following state’s footsteps, rules and regulations take a secular form. In South Asian, the legal system of India, Sri Lanka, Nepal and Bhutan are deemed to be secular. It is no doubt that some influence of Hindu Law is traceable in all these systems. But, as far as this influence does not result in discrimination on the basis of religious believes and identities, we cannot conclude that they are unethical and therefore non-ideal. Under legal systems that are independent of religion, many rights such as freedom of thought, freedom of religion and freedom of speech can be guaranteed. In addition, such systems can be more effective in preventing discriminations that occur on the basis of gender, sex, race, color and religious identity. This is while in almost all religious systems of law, some form of discrimination on the basis of the above-mentioned factors is traceable.

Conclusion

On the basis of the above discussions, we can conclude that it is ideal if the legal system of a country is completely independent of religion. This way, religion and religious rules will not be exploited by authorities in power to justify injustice against certain groups of people. With religion effectively out of the realm of legislation, many basic freedoms will be guaranteed for a given society, and many forms of discrimination that can take place on the basis of religious identity or any other basis but motivated by religion, can be prevented. The intervention of religion in legislation can cause various violations of rights and liberties. Thus, on ethical grounds, we cannot accept the dependence of legal systems on religion as a source of legislation as ideal. However, it should be noted here at the conclusion that by no means I am saying that religion in itself is unethical. What I want to be clear about is that when religion is formally brought into the realm of legislation and when religious sources are formally accepted as the sources for legislation, it becomes prone to misuses that produce unethical results. Once the legal system is laid down on religion, it is very difficult to avoid misuses that produce ethically unjustified results. Hence, it is optimal and ideal to keep legal systems secular and independent of religion

Should We Worry about Income Divergence or Not?

Charles Kenney, in his paper titled “Why to worry about income when other quality of life indicators are converging?” tries to show that quality of life variables other than income are all converging; so, there is no need to worry about inequalities. As far as the numbers and quantities of the indicators he is talking about are concerned, I can agree with him. However, when it comes to the quality of the indicators, I have some questions and concerns that make me worry about income divergence.

The quality of life variables that Kenny is talking about consist of average basic health indicators such life expectancy, infant mortality rates, literacy, civil rights, political rights, primary school enrollment, access to everyday communication technology, child labor, total education per capital and some other social indicators. As he has shown, basic indicators are converging. For example, the number of children getting enrolled every year in developing countries are increasing rapidly and hence getting closer and closer to those numbers of enrolment in the developed world. But, we can ask a valid question here: is the quality of primary education also converging? Take Afghanistan for example, the number of enrolment in primary, secondary and tertiary schools have drastically increased over the past 20 years. However, a very big portion of these number of students are having the following problems: no regular teacher, lack of books, no school building. Solving all these problems need a stronger income. Given this, should Afghanistanis worry about income or not? I think they should. The case of India, which comes second after China amongst developing countries, is not very different in terms of education quality from that of Afghanistan. The numbers of children enrolment are remarkably significant; but, the quality is still very low, and to improve the quality, India needs more money. Higher-income can help India improve the quality of education both through direct investment and through improving relevant institutions.

We can ask such valid questions almost about all those indicators that Kenny talks of convergence in them. For example, when it comes to civil rights and political rights, the quality of civil rights in the developed world is far more ahead of what we have in the developing countries. Civil institutions and political institutions are weak and may not grow to the level of developed nations if GDP and income of the global south are falling behind the global north. I strongly doubt such a possibility in the absence of high income. The basics, structures and models of such institutions can be imported from the developed countries, as has been the case in  Afghanistan, and some other third world nations; but, the quality cannot be imported. There is a need for more money, stronger income and GDP to improve and well-establish such institutions. As Ha-Joon Chang argues, there is a strong causality running from economic development to better institutions. He particularly stresses the point that economic development increases the demand for better institutions and more transparency. So, to have developed institutions such as those in the developed world income convergence matters.

In the face of Covid-19 pandemic, we see how the quality of institutions, the quality of the health-care system, and the quality of education (for covid-19 research) and the strength of income have increasingly become important. This pandemic has shown that even if all other indicators are converging, but income is not, then your vulnerability remains very high. What Charles Kenny is suggesting cannot explain how developing countries will ensure that they will converge to developed nations when it comes to technological researches. For technological researches and making advances in these areas, heavy investments are needed. Only high-income countries can bear it. One might not be wrong to say that tech advances are now the backbone of economic development and economic competition.

 To sum up, I can agree with Kenny to the extent that low-hanging indicators and indicators that have a higher bound on them are concerned. However, this does not suffice to stop me from worrying about the divergence of income. The income divergence may push for further inequality when it comes to the quality of “quality of life indicators”. Hence, income convergence is needed to have a real convergence rather than being delighted by somewhat superficial convergence.

Bibliography:

Kenny, C. (2005). Why Are We Worried About Income? Nearly Everything that Matters is Converging. World Development, 33(1), 1-19. doi: 10.1016/j.worlddev.2004.06.016

CHANG, H. (2010). Institutions and economic development: theory, policy and history. Journal Of Institutional Economics, 7(4), 473-498. doi: 10.1017/s1744137410000378

Systematic Sex Selection and the Long-term Pattern of Development

• Introduction:

As research has shown, systematic sex selection is a prevalent phenomenon in South Asian countries, which are predominantly underdeveloped. In this writing, we want to know whether or not it has any impact on the long term pattern of development in these countries. Hence, it is necessary to explore the types of possible relationships that systematic sex selection and the long term pattern of development could have.

• What are the possible and thinkable relationships between systematic sex selection and the long term pattern of development?

We can think of several types of relationships between systematic sex selection and the long term pattern of development. One can be that the former might causally affect the latter, and the effect might be negative. In other words, systematic sex selection might act as a barrier for long term development to happen. It could also be possible that the development process itself might cause systematic sex selection to reduce. Another thinkable relationship is that the two might be interrelated in the sense that each one might affect each other – systematic sex selection might affect the long term pattern of development and vice versa. One even might argue that they are not related to each other at all. In the coming paragraphs, we will try to open up these points and discuss them in more detail.

• A negative causal relationship between systematic sex selection and the long term pattern of development?

If we define sex selection as “an act that ‘should’ result in the death of a female fetus or female baby”, then for such a narrow definition of sex selection, systematic or non-systematic, I don’t see any obvious direct causal relationship between sex selection and long term patter of development when development is defined mainly as growth in GDP and incomes. We might find some indirect relation through the social consequences of systematic sex selection. However, if we define development in a broader sense that includes progression in human rights fronts, social inclusion, equality, and economic justice, then of course systematic sex selection is a high barrier blocking long-term development.

Similarly, if we define systematic sex selection as a process that “might” (not should) result in the death of a female fetus or female baby but “include post-natal sex discrimination as an inevitable part of this process”, then, no matter what the definition of development be, systematic sex selection avoids development. For development to happen, it is necessary that all the sections of society are included in the process. Any discrimination against any section will result either in partial and exclusive development (development for a certain section of society) or in underdevelopment. In a society where systematic sex/gender discrimination is unleashed against women, a big chunk of society – women – will be deprived of their rights, liberties, and not sufficiently educated. Liberated and equally (to men) educated women can make a huge contribution to production, income (through female labor force participation), and hence the welfare of society. This is while deprived, underrepresented, non-educated, and oppressed women would much probably be a burden for a developing economy. In other words, systematic post-natal sex selection, when thought of as an umbrella for systematic sex discrimination, can have a negative effect on the long-term pattern of development.

•  Development as a process that curbs systematic sex selection

Looking into the facts from the perspective of economies that are called “developed”, we might conclude that the development process curbs systematic sex selection. The point I want to make here is that systematic sex selection can be seen as a characteristic of underdeveloped/developing economies, and once development occurs and economies become fully mature in terms of development, the systematic sex selection will disappear. In other words, we can look at it in the same way we look at poverty rather than trying to see it as a barrier to a long-term pattern of development. We see high levels of poverty as a characteristic of developing economies. Once an economy matures in terms of development, poverty reduces sharply. The delicate point I want to communicate is that the development process should be seen as a solution to systematic sex selection in developing countries. Communicated differently, from what we see in the developed world we might be correct to say that some form of causality is running from the development process to the disappearance of systematic sex selection. Now, one might ask about the elements inside the “development process” toolbox that curb systematic sex selection. My answer is strong institutions, rule of law, good governance, educated and well-informed society.

• Interrelation in the sense that each one might affect one another?

Following the above line argument, we can state that it seems there exists an interrelation between systematic sex selection and the long term pattern of development. It means they might have mutual effects on one another. The impact of systematic sex selection on the long term pattern of development, as discussed above, seems to be negative. Similarly, the impact of the development process on systematic sex selection, as suggested by the status of developed countries and the experience of Japan, appears to be negative. According to Amartya Sen “in the censuses of 1899 and 1908 Japan had a clear and substantial deficit of women, but by 1940 the numbers of men and women were nearly equal, and in the postwar decades, as Japan became a rich and highly industrialized country, it moved firmly in the direction of a large surplus, rather than a deficit, of women” (Sen, 1990).

• No relationship between the two?

One might even argue that there exists no relationship between systematic sex selection and long term pattern of development. Statistics from China suggest that systematic sex selection is very prevalent in China. This is while the country is moving very fast towards development. In other words, the statistics suggest that even fast-paced development can happen despite the existence of systematic sex selection. However, one might counter this point saying that the development taken place in China is not a long-term pattern. Also, it can be countered arguing that the prevalent type of sex selection in China is of the pre-natal sort. Hence, it does not affect the economic growth and development of the country. As discussed above, post-natal systematic sex selection cannot be separated from systematic sex discrimination, and it is, in fact, systematic sex discrimination that stands as a barrier against development.

• Conclusion 

Several types of relationships between systematic sex selection and the long term pattern of development are thinkable. However, it seems that an inverse mutual relationship between the two is strong and more plausible. Systematic sex selection stands a barrier against development when development is defined in a broad sense that includes various rights, liberties, equality, and economic justice. Development as a process, through strong institutions, rule of law, good governance and education curbs systematic sex selection. From this conclusion, we can make a keynote and it is the fact that even if systematic sex selection stands in the way of a long-term pattern of development, we might not be able to do anything effective about it unless we reach some certain level of development where institutions, government and rule of law are strong and capable of countering systematic sex selection.

Reference

Sen, A. (1990). More Than 100 Million Women Are Missing. The New York Review of Books.