informality Flashcards
who makes up the informal sector
low and middle income countries - 30 - 70% of GDP and 20-80 %of the labour force and a large share of firms
what are the implications of having a large informal sector
- Substantial fraction of economic activity is completely unregulated; taking
place at the margin of tax, labour, and other relevant regulatory frameworks. - Deep implications for the behaviour of firms, workers, families, and consumers.
- Combines to have important effects on the aggregate outcomes such as
productivity, output, and growth.
what is informality
- those who do not comply with the relevant laws and regulations
for worker: no formal labour contract
for firms: not registered with tax authorities
How do many formal firms evade labor regulation costs?
By hiring informal workers.
How do formally registered firms partially comply with tax regulations?
By underreporting revenue to evade taxes.
what is the relationship between informality and economic development
negative relationship - but there is high variation between income groups
what are the characteristics of workers in the informal sector (3)
- U-shape pattern with respect to age,
i.e. it is larger among younger and older workers. - higher among women and decreases with schooling (e.g. Perry
et al., 2007; Gasparini and Tornarolli, 2009). - Transitions in and out of informality follow a similar pattern: the young,
women, and low-skilled workers have a higher probability of transiting from
unemployment and formal jobs into informal employment - middle aged and college graduates afre more likely to be in formal employment
- what is the buissness related to the informal sector
informal employment (like unemployment) has been shown to be strongly
counter-cyclical; i.e. it expands during recessions and decreases during
economic booms (as a fraction of employment)
why is informal employment counter cyclical
- the job finding rate in the formal sector is strongly pro-cyclical, but it is fairly
stable in the informal sector - the informal to formal transitions are pro-cyclical
- the separation rates (quit rate) is more volatile in the informal sector.
what happens to the wage gap of informal workers
- Ulyssea (2018) uses matched employer-employee data on both formal and
informal firms in Brazil to estimate the wage gap with firm-fixed effects;
i.e. comparision of informal and formal workers within the same firm - ## The estimated within-firm wage gap is statistically and economically zero
- how does the firm type affect informality
- Informal firms are on average smaller (both in terms of employees and
revenues), pay lower wages, are run by less educated individuals, hire less
educated workers and earn lower profits than formal firm - it does not support the dualistic view of informality - firms co exsist within the same industry and produce similar products
what happens when firms grow in size in the informal sector
- Share of informal firms rapidly declines as firms grow larger
- The cost of operating in the informal sector are increasing in the firm size
what are the oppitunity costs of operating in the informal sector as the firm size increases
- larger informal firms have a hard time remaining undetected by the govt
- large firms need access to formal credit lines.
- need to issue invoices to buyers
What does the “intensive margin” refer to in an informal economy?
It refers to the extent of informality within firms that are already operating informally.
What aspects are examined at the intensive margin in an informal economy?
The amount of economic activity or employment conducted informally within a firm.
what happens to intensive as informal firms grow larger
average share of informal
employees within formal firms declines with firm size.
why as firms get larger do they operate less in the informal sector
- Larger firms are more visible and therefore, more likely to be inspected.
- costly to inspect small firms and therefore, government’s
inspectors tend to focus on larger firms
what could policy makers do to reduce informality in the country
- reduce the cost of informality
- Increase the benefits of formality
- Increase the cost of informality
what do De Andrade, Bruhn and McKenzie (2016) investigate
Conduct a field experiment in the city of Belo Horizonte in Brazil to test
whether government actions work to encourage informal firms to register.
what do the results say about the methods for limited effects for informality from experimental and quasi experimental studies
- providing information about the process of registration and its potential
benefits (De Giorgi and Rahman, 2013) - nformation and reimbursing all registration costs (De Mel et al., 2013; de
Andrade et al., 2016) - creating national formalisation programms that substantially reduce
registration costs
what have the largest formalisation effects accordinf tothe literature
reduce the costs
of staying in the formal sector or that increase the benefits of formality.
▶ De Mel et al. (2013) find a subsantial compensation for formalising (an
equivalent of two months’ profits for the median firm) is offered along with
registration costs, there is a formalisation effect of 47%.
▶ Similarly, Rocha et al. (2018) in Brazil find eliminating entry costs for eligible
entrepreneurs had null effect on formalisation.
▶ Reducing the entry costs and reducing the tax burden faced by entrepreneurs
increased formalisation by 11%.
what is the informality framework
1.De Soto (1989): Informal sector is composed of potentially productive
entrepreneurs who are kept out of formality by high regulatory costs, in
particular entry regulation.
2. “Parasite View”: informal firms are “parasite firms”: they could survive in the
formal sector but choose to remain informal to earn higher profits by not
complying with the relevant taxes and regulations.
3. “Survival View”: informality is a survival strategy for low-skill individuals; too
unproductive to ever become formal.
Informality Framework applied to Brazil (Ulyssea, 2018)
In the context of Brazil, “De Soto View” accounts for a small fraction of
informal firms, 9.3%. Thus, reducing regulatory costs will not lead to high
levels of formalisation but would lead to higher productivity and growth for
firms in this framework.
▶ “Parasite View” implies that the government should increase enforcement for
optimal allocation of resources from informal to formal firms.
▶ “Survival View” imples increasing enforcement would not mean firms can not
survive. This leads to negative social consequences by eliminating livelihoods
of the most vulnerable individuals and increasing unemployment.
how does the tax structure affects firms
the tax credit may be a key determinant of a firms decision to be formal
- purchases from informal suppliers do not generate tax credits and informal firms cannot generate tax credits from their own supplies
how does trade affect the informality market
- Strong effects of trade on both firm and labour informality
- Cisneros-Acevedo (2022) analyses the impact of import tariff reduction in
Peru: exposure to foreign competition leads to higher informality among low
skilled workers, but with two opposing forces:
the least productive (informal) firms exit: extensive margin (reduce
informality)
formal firms cut costs faced with the competition by hiring informal workers:
on the intensive margin (informality increases)
In Peru, the latter effect dominated and overall informality increased..
what affect can informality have on trade
- higher informality can help reduce employment losses and its a flexible form of employment
- Ponczek and Ulyssea (2022) show that informality can help reduce
employment losses after a negative shock. - The regions with weaker enforcement observed higher informality effects but
no unemployment effects. - In areas with stronger enforcement, there was much higher lay off.
- in the long run when enforcement is stronger welfare is actually higher even if it comes at a cost of greater unemployment
what are the consequences of informality in firms
- This lack of effect is consistent with the argument that the perceived
benefits of formalization are very low for most small-scale entrepreneurs - It might be the case that the positive effects of formality take long to appear. Even then, these results are not encouraging, as the costs kick in
upon formalization. - it has no affect on the firms performance or any other meaningful behaviour and very few firms experience substantial economic growth
how informality affects tax policy
- informality increases the efficiency cost of taxing consumption because
households can switch to informal varieties when tax on formal ones increase. - food subsidies ends up redistributing very little or benefiting mostly richer
households. - Presence of a large informal sector in developing countries makes
consumption taxes progressive. - Informality may affect the distributional consequences of tax policy in
developing countries in subtle ways.
Informality can lead to lower levels of aggregate human capital via two
equilibrium mechanisms:
- lower individuals investment in schooling
- lower on the job capital accumulation
why would individuals invest less in schooling
- informality reduces the effective returns to schooling; implies less investment
in education - eliminating informal jobs can increase schooling investments by 10% but at
the cost of decreasing welfare of workers and firms
Lower on-the-job human capital accumulation.
evidence suggests that learning on the job is slow; career progression is small.
