Unveiling the Informal Economy: An Augmented Factor Model Approach

IMF Working Papers, May 31, 2024

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Develops a new approach to estimating the degree of informality in an economy.
Combines direct yet infrequent measures of the informal economy in micro data with an augmented factor model that links macro indicators of the informal economy to its causes.
Demonstrates that the prevailing model in the literature, the multiple indicators multiple causes (MIMIC) model, is a special case of the augmented factor model.
Uses component analysis and factor models to relate macro indicators (including nighttime light and electricity indicators) to informality, integrating survey data such as WBES data.

The augmented factor model provides a more complete picture of the informal economy than the MIMIC model.
The dynamics of the informal economy are shaped by:
- the strength of overall economic activity, and
- the interplay between the formal and informal economies.
Contrary to previous work that typically finds declining informality for most countries, this paper finds that the degree of informality has increased for low-income countries for the past two decades.

Subject: Commodities, Consumption, Econometric analysis, Economic sectors, Electricity, Factor models, Informal economy, Monetary base, Money, National accounts
Keywords: augmented factor model, component analysis, Consumption, D. adding nighttime, Electricity, Factor models, Global, indicators of the informal economy, Informal economy, Informality, MIMIC model, Monetary base, nighttime Light, survey data, WBES data

Researchers: Consider the augmented factor model as a general framework encompassing MIMIC when estimating informality; exploit the combination of micro survey measures and macro indicators.
Policy analysis: Pay attention to how overall economic activity and formal–informal sector interactions influence informality, particularly in low-income countries where informality has increased over the past two decades.

Source: IMF Working Paper "Unveiling the Informal Economy: An Augmented Factor Model Approach" by Jiaxiong Yao, May 31, 2024.