Digitalisation, e-Governance and the informal sector

This paper shows that digitalisation does not necessarily reduce the size of informality and would depend on the rule of law and effective judicial systems. We build a simple model with heterogeneous labour markets where the formal sector firms meet the tax required for digitalisation and e-Governance for the informal transactions, avoiding the tax burden. Digitalisation that increases the chances of being caught in informal transactions directly encourages formal activities. However, it demands higher taxation, which works in the opposite direction. The relative strength of these two forces determines the size of informality, suggesting a non-linear relationship. The enforcement of minimum wage or productivity requirements may raise the size of informality. The econometric results from cross-country panel data for around 152 countries from 1990 to 2017 revealed a U-shaped relationship between informality and digitalisation. However, the negative impact gets stronger under the improved judiciary system and rule of law.