Access to credit markets and informality

Kaushal Basnet


One of the biggest characteristics in the developing world is the existence
of large informal sectors. In this paper, we develop a model of an
individual’s choice between operating in the formal sector or the informal
sector. Using the occupational choice model developed by Lucas (1978) and
adopted in Haniff (2015), we analyze the choices of an individual based on
their level of skills and assets, given the economy’s level of accessibility to
credit markets.
We find that individuals with high ability who lack assets, needed for
collateral, are not able to get loans to pay for the costs associated with formalization,
and choose to operate in the informal sector. Lack of access to
credit markets further increases the cost of formalization due to increase in
financial costs.


Credit Markets, Economic Development, Growth, Entrepreneurship, Informal sector, informality

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Journal of Development Innovations

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