AbstractInformal economy involving unrecorded, unregistered, extra‐legal activities employs majority of the work force in the developing world. Such extra‐legal existence of informal production is facilitated through extortion by agents of political forces in power. Also, extortion activities themselves constitute an informal segment. Full‐scale general equilibrium consequences of such institutions are rarely discussed in the literature. We develop a well‐specified general equilibrium model to explore the possible consequences of reform. Economic reform may have an expansionary effect on the number of extortionists. Depending on capital mobility and factor intensity assumptions informal output and informal wage may increase.