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The Demand for, and Consequences of, Formalization among Informal Firms in Sri Lanka

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Author Info

  • de Mel, Suresh

    ()
    (University of Peradeniya)

  • McKenzie, David

    ()
    (World Bank)

  • Woodruff, Christopher

    ()
    (University of Warwick)

Abstract

The majority of firms in most developing countries are informal. We conducted a field experiment in Sri Lanka which provided incentives for informal firms to formalize. Offering only information about the registration process and reimbursement for direct registration costs had no impact on formalization. Adding payments equivalent to one-half to one month's profits for the median firm leads to registration of around one-fifth of firms. A larger payment equivalent to two month's median profits induces half of the firms to register. Among the firms not registering after being offered this larger incentive, many faced issues related to ownership of land. Three follow-up surveys at 15 to 31 months after the intervention measure the impact formalizing has on these firms. Although mean profits increase, this appears largely due to the experiences of a few firms which grew rapidly, with most firms experiencing no increase in income as a result of formalizing. We also find little evidence for most of the channels through which formalization is hypothesized to benefit firms, although formalized firms do advertise more. Finally, formalizing is found to result in a large increase in trust in the state.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 6442.

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Length: 37 pages
Date of creation: Mar 2012
Date of revision:
Publication status: published in: American Economic Journal: Applied Economics, 2013, 5 (2), 122-50
Handle: RePEc:iza:izadps:dp6442

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Keywords: small enterprises; entrepreneurship; informality;

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References

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  1. McKenzie, David & Sakho, Yaye Seynabou, 2007. "Does it pay firms to register for taxes ? the impact of formality on firm profitability," Policy Research Working Paper Series 4449, The World Bank.
  2. Chang-Tai Hsieh & Peter Klenow, 2009. "Misallocation and Manufacturing TFP in China and India," Working Papers 09-04, Center for Economic Studies, U.S. Census Bureau.
  3. Marianne Bertrand & Francis Kramarz, 2002. "Does Entry Regulation Hinder Job Creation? Evidence From The French Retail Industry," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1369-1413, November.
  4. Miriam Bruhn, 2011. "License to Sell: The Effect of Business Registration Reform on Entrepreneurial Activity in Mexico," The Review of Economics and Statistics, MIT Press, vol. 93(1), pages 382-386, February.
  5. de Mel, Suresh & McKenzie, David & Woodruff, Christopher, 2007. "Returns to capital in microenterprises : evidence from a field experiment," Policy Research Working Paper Series 4230, The World Bank.
  6. McKenzie, David, 2011. "Beyond baseline and follow-up : the case for more t in experiments," Policy Research Working Paper Series 5639, The World Bank.
  7. Rafael La Porta & Andrei Shleifer, 2008. "The Unofficial Economy and Economic Development," NBER Working Papers 14520, National Bureau of Economic Research, Inc.
  8. Fajnzylber, Pablo & Maloney, William F. & Montes-Rojas, Gabriel V., 2011. "Does formality improve micro-firm performance? Evidence from the Brazilian SIMPLES program," Journal of Development Economics, Elsevier, vol. 94(2), pages 262-276, March.
  9. Guillermo E. Perry & William F. Maloney & Omar S. Arias & Pablo Fajnzylber & Andrew D. Mason & Jaime Saavedra-Chanduvi, 2007. "Informality : Exit and Exclusion," World Bank Publications, The World Bank, number 6730, October.
  10. Kaplan, David S. & Piedra, Eduardo & Seira, Enrique, 2011. "Entry regulation and business start-ups: Evidence from Mexico," Journal of Public Economics, Elsevier, vol. 95(11), pages 1501-1515.
  11. David Kaplan & Eduardo Piedra & Enrique Seira, 2007. "Are Burdensome Registration Procedures an Important Barrier on Firm Creation? Evidence from Mexico," Working Papers 0701, Centro de Investigacion Economica, ITAM.
  12. de Mel, Suresh & McKenzie, David J. & Woodruff, Christopher, 2009. "Measuring microenterprise profits: Must we ask how the sausage is made?," Journal of Development Economics, Elsevier, vol. 88(1), pages 19-31, January.
  13. Rafael Di Tella & Sebastian Galiani & Ernesto Schargrodsky, 2007. "The Formation of Beliefs: Evidence from the Allocation of Land Titles to Squatters," The Quarterly Journal of Economics, MIT Press, vol. 122(1), pages 209-241, 02.
  14. Klapper, Leora & Laeven, Luc & Rajan, Raghuram, 2006. "Entry regulation as a barrier to entrepreneurship," Journal of Financial Economics, Elsevier, vol. 82(3), pages 591-629, December.
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Citations

Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. The Illusion of Information Campaigns: Just because people don’t know about your policy, it doesn’t mean that an information campaign is needed
    by ? in Development Impact on 2013-05-06 13:00:00
  2. How much do firms want to stay informal?
    by Economic Logician in Economic Logic on 2013-06-14 14:58:00
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Cited by:
  1. Bruhn, Miriam & McKenzie, David, 2013. "Using administrative data to evaluate municipal reforms : an evaluation of the impact of Minas Facil Expresso," Policy Research Working Paper Series 6368, The World Bank.
  2. LaPorta, Rafael & Shleifer, Andrei, 2014. "Informality and Development," Scholarly Articles 12343780, Harvard University Department of Economics.
  3. Todd Kumler & Eric Verhoogen & Judith A. Frías, 2013. "Enlisting Employees in Improving Payroll-Tax Compliance: Evidence from Mexico," NBER Working Papers 19385, National Bureau of Economic Research, Inc.
  4. Margolis, David N., 2014. "By Choice and by Necessity: Entrepreneurship and Self-Employment in the Developing World," IZA Discussion Papers 8273, Institute for the Study of Labor (IZA).
  5. de Andrade, Gustavo Henrique & Bruhn, Miriam & McKenzie, David, 2013. "A Helping Hand or the Long Arm of the Law? Experimental Evidence on What Governments Can Do to Formalize Firms," IZA Discussion Papers 7402, Institute for the Study of Labor (IZA).
  6. De Giorgi, Giacomo & Rahman, Aminur, 2013. "SME’s registration: Evidence from an RCT in Bangladesh," Economics Letters, Elsevier, vol. 120(3), pages 573-578.

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