A Model of the Informal Sector in Development

In discussions of economic development, industrial dualism is often ignored. Industry, or the modern sector, in developing countries is composed of an overregulated formal sector and a free‐entry informal sector. Because of the nature of the regulations we can, in general, identify the formal sector with large industry and the informal sector with small industry. The informal modern sector is often a dynamic actor in the process of economic development, frequently outpacing the growth of the formal modern sector. We investigate in a general equilibrium model the conditions under which the informal sector increases its capital stock more rapidly than the formal sector. We also look at the employment‐unemployment effects of industrial dualism.