Institutions, Entrepreneurs, and the Informal Economy

Abstract: The informal economy has been on an upward trend around the world since the 1980s. While most of the latest research has concentrated on the labor and size measurement aspects of the informal economy, there is little research on the business aspect of the informal economy. This study investigates the institutional mix that determines business formation, including the informal economy. It constructs an entrepreneurial choice model, based on the payoffs associated with existing opportunities. The available choices are: opening a business in the formal sector, obtaining a rent seeking position, and opening a business in the informal sector. The expected income is treated as the profit of a firm and as a function of capital investment in the enterprise. The entrepreneurial choice is influenced by the institutional incentives in an economy, expressed as a mix of public goods and cost of doing business. The purpose of this research is to bring a framework to entrepreneurial choice under the impact of institutions.