How Much is too Much? An Endogenous Growth Model with an Optimal Level of Informality
How Much is too Much? An Endogenous Growth Model with an Optimal Level of Informality

Summary/Abstract: We develop an endogenous growth model in which informal practices, trust and transaction costs take the key role and dictate the speed of the long-term economic development. A decision maker chooses how much informal behaviour to allow in the economic system in order to maximize the rate of innovation by taking into account the productivity gains and loses associated with building trust and lowering transaction costs. The model shows that economic systems in which changes in informal practices are taken into account will grow at a faster rate compared to economic systems in which the same changes are ignored. This provides an alternative explanation to divergence in output per capita between different countries from the point of view of the new institutional economics.

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