Determinants Of Informality (De Andrade (2parts) , De Mel, Bujand (Mexico SSI), Ciscandes (trade on informality)

Question 1

Ways policymakers can reduce informality (3)

Answer 1

Reduce cost of formality
Increase benefits of formality
Increase cost of informality (more inspections etc)

Question 2

How can they reduce cost of formality (2)

Answer 2

• costs of entry e.g registration costs
• Costs of remaining formal e.g tax/compliance regs

Question 3

How can we increase benefits of formality

Answer 3

Improve credit access when formal)

Question 4

De Andrade - what was it?

Answer 4

If gov actions encourage informal firms to become formal

Question 5

How did they do this?

Answer 5

Consolidating multiple taxes into a single payment to reduce tax burden. (Reducing cost of formality)

Question 6

Findings

Answer 6

72% firms still informal (so not much impact)

Question 7

To understand reasons for not going formal: De Andre tested 5 groups (5)

Answer 7

1. Control
2. Info on how to formalise
3. Info + no registration fee + 1 year free accounting services (to reduce costs)
4. Municipal inspectors visited firms (increase costs of informality)
5. Neighbouring firm visited by inspector (to see spillover effect, may become scared)

Question 8

Main findings between groups (3)

Answer 8

Treatment 1 & 2 (info on how to formalise) had no impact on formalisation rate.

Inspections increased formalisation by 3% (low as some firms closed, not finding others, and measurement error i.e some already now formal)

No evidence on spillovers as firms said they did not communicate much with neighbouring firms (supports Conley&Udry/DKR who opposes F&R

Question 9

What was the reason firm owners iterated themselves for not going formal?

Answer 9

Did not trust government

Question 10

De Mel: case study in Sri Lanka: how many firms are unregistered with government there?

Answer 10

1/5 of firms

Question 11

What does this high level of informality result in? (2)

Answer 11

Lower tax revenue - difficultly to fund public services

Inefficient allocation of resources - due to different MCs of informal/formal

Question 12

So in De Andrade they say they do not trust the government so remain informal.

What reason do firms report for being informal in De Mel

Answer 12

Issues with land tenancy prevents them from becoming formal, many lack proof of ownership of land.

(May have been owned for generations so do not have actual documentation etc)

Question 13

So De Andre did consolidating tax into a single payment. Which had little effect. So he then tried info, free entry/accounting, inspections, neighbour inspections. (Only inspections of own firm increased formality 3%)

De Mel groups? (5)

Answer 13

1.Control (the informal firm operates as usual)
2.Info + reimbursed registration cost
3. Info + reimbursement + 10,000 Sri Lankan Rs
4. Info + reimbursement + 20,000 Sri Lankan Rs
5. Info + reimbursement + 40,000 Sri Lankan Rs

(So control, 1 info and reimbursement, 3 info+reimbursement+cash)

Question 14

Results for each treatment group

Answer 14

T1: Info and reimbursement did not induce registration. (Similar in De Andrade)

17-22% registered when given 10K or 20K (which is 1 month profit for median firm)

T4: 48% registered for 40k, and those who did not, changed their mind when given additional time or offered 80k

(So capital incentive seems an influence, unlike investment with farmers where they responded to insurance rather than cash!)

Question 15

There was a follow up survey to assess the long term findings.

What did they find? (2)

Answer 15

Formalised firms have higher profits.
Eval: due to a few firms substantial growth rather than all firms experiencing higher profits

Formal firms trust government more (unlike De Andrade), so accept to pay tax, but also think small business are taxed too much

Question 16

So what do the authors estimate using profits, costs and taxes

Answer 16

A downward sloping demand curve.

As cost of formality falls, demand to become formal increases.

Question 17

Bujanda: case in Mexico to see how firms respond to increasing cost of informality.

How did they do this?

Answer 17

Had to register workers with Social Security Institute to pay taxes. Had random inspections, so if caught face a fine.

Question 18

Results
What happened to probability of informal worker turning formal?

What happened to firm growth?

Poaching?

Wages for organically formalised workers vs switched

Answer 18

Increased 14% to 21%.

Firm growth fell by 2% (since higher costs - pay more tax)

Employees that transitioned from informality to formality were more likely to get poached by another firm offering formal employment

Wages for organically formalised 1.4% higher, then disappears

Question 19

How can employers link formality to productivity

Answer 19

Employers using formality status as a signal of worker productivity.

(Since pay formal workers more as more productive)

Question 20

So overall:

Where do the largest formalisation effects come from? (2)

Answer 20

Reducing costs of STAYING in formal sector (e.g reducing tax) (not cost of turning formal e.g with reimbursement/free fees)

Increasing benefits of formality (De Mel where they responsive to money packages)

Question 21

Evaluation of reducing costs of formality: what is an issue

Answer 21

Loss of tax revenue

Question 22

Informality framework: 3 ideas

Answer 22

De Soto - informal sector has potentially productive entrepreneurs who are kept out of formality by high regulatory costs i.e entry costs

Parasite view - informal firms are parasites - they can survive in formal sector but choose to remain informal to gain higher profits by avoiding tax/regs

Survival view - informality is a survival strategy for low skill individuals - too unproductive to become formal

Question 23

How would this framework apply to Brazil

Answer 23

For De Soto’s view, the figure is only 9.3%. (Only 9.3% of informal firms have this ‘potentially productive trait but deterred by entry costs’).

So reducing the entry costs will not lead to a large increase in formalisation, maximum is 9.3%!

Parasite view - increasing enforcement (random inspections) would improve optimal allocation of resources (since they are firms that can survive anyways, and avoids the different MC issue!)

Survival view - increasing enforcement means firms will not survive, cause negative consequences.

Question 24

So what is the key problem with this framework

Answer 24

Distinguishing parasite firms vs survival firms.

If done incorrectly e.g increasing enforcement for a survival firm thinking it is a parasite, will just kill the firm.

Question 25

Additional determinants on decision to become formal

Answer 25

Tax
Trade - more foreign competition > more informality

Question 26

Cisneros Acevedo: what happened, and findings

Which effect dominated?

Answer 26

Effect of tariff reduction: (increased trade + foreign competition)

Least productive informal firms exit following foreign competition. (This reduces informality - remember formality signals high productivity!!!)

But then formal firms reduce costs by hiring informal workers. (Informality increases)

The latter dominated, so informality increased overall!

Question 27

Pro of higher informality and Eval

Answer 27

Can help reduce unemployment since it is flexible

But in long run, welfare is higher when enforcement is high, even at the cost of greater unemployment of informal workers.