The paper corroborates widely observed empirical fact that globalization does increase the size of the informal sector. Liberal trade policy in the form of a decline in tariff reduces open unemployment and increases informal wage and informal employment under reasonable assumption if capital is mobile between the formal and the informal sectors. Liberalization process hurts both organized manufacturing and traditional agriculture and leads to a booming informal sector. Any attempt to artificially raise employment in the formal sector by a wage subsidy leads to higher overall unemployment. Results change drastically when capital is not allowed to be mobile. Thus capital mobility between the formal and informal segments emerges as a critical factor.

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