Parity, Paternalism and Peonage in the Informal Economy: an Empirical Study of Off-the-books Loans

Abstract: Responding to the call for deeper analysis of the informal economy using innovative data and methods, our study tests and extends existing theory through transaction-level data involving off-the-books loans issued to employees by business owners. Our analysis of 459 separate transactions from 83 firms reveals that individuals will engage in informal economic activity even when formal market alternatives exist if those formal alternatives are unattractive or unfair. By extending key theoretical tenets of relational exchange and relational rents into this new context, we demonstrate that surplus can be created when owners and employees abandon formal markets and institutions by resorting to complementary exchange through informal economic mechanisms. This study of off-the-books transactions provides a rare portal to informal market decision-making and behavior. We find that business owners can internalize the information costs related to an employee's credit worthiness at a lower cost than can be achieved by formal credit markets. In complementary fashion, a valued employee can internalize more cheaply the owner's information costs related to identifying good and faithful labor. Paradoxically, however, we find that credit-challenged workers who obtain short-term financial relief through off-the-books loans also find themselves subject to disadvantageous forces of paternalism and peonage, particularly minority employees. Our study reveals that while both parties share in the creation of a relational surplus, business owners deftly appropriate the surplus by binding employees to the firm. The findings strongly support notions propounded by Venkatesh, Portes and others that the informal economy simultaneously creates opportunities and complications for disadvantaged participants.