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The Informal Sector: An Equilibrium Model and Some Empirical Evidence from Brazil

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  • Aureo de Paula

    ()
    (Department of Economics, University of Pennsylvania)

  • Jose A. Scheinkman

    ()
    (Department of Economics, Princeton University)

Abstract

We test implications of a simple equilibrium model of informality using a survey of 48,000+ small firms in Brazil. In the model, agent's ability to manage production differ and informal firms face a higher cost of capital and limitation on size, although these informal firms avoid tax payments. As a result, informal firms are managed by less able entrepreneurs, are smaller and employ a lower capital-labor ratio. When education is an imperfect proxy for ability, the model predicts that the interaction of the manager's education and formality is positively correlated with firm size. Using the model, we estimate that informal firms in our dataset faced at least 1.3 times the cost of capital of formal firms.

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Bibliographic Info

Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 09-044.

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Length: 30 pages
Date of creation: 02 Dec 2009
Date of revision:
Handle: RePEc:pen:papers:09-044

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Keywords: Informal Sector; Tax Avoidance; Brazil;

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References

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  1. Straub, Stéphane, 2005. "Informal sector: The credit market channel," Journal of Development Economics, Elsevier, Elsevier, vol. 78(2), pages 299-321, December.
  2. Friedman, Eric & Johnson, Simon & Kaufmann, Daniel & Zoido-Lobaton, Pablo, 2000. "Dodging the grabbing hand: the determinants of unofficial activity in 69 countries," Journal of Public Economics, Elsevier, Elsevier, vol. 76(3), pages 459-493, June.
  3. �ureo de Paula & Jose A. Scheinkman, 2010. "Value-Added Taxes, Chain Effects, and Informality," American Economic Journal: Macroeconomics, American Economic Association, American Economic Association, vol. 2(4), pages 195-221, October.
  4. Gabriela Inchauste & Mark Gradstein & Era Dabla-Norris, 2005. "What Causes Firms to Hide Output? the Determinants of Informality," IMF Working Papers, International Monetary Fund 05/160, International Monetary Fund.
  5. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, Elsevier, vol. 66(2), pages 293-312, November.
  6. Loayza, Norman V., 1996. "The economics of the informal sector: a simple model and some empirical evidence from Latin America," Carnegie-Rochester Conference Series on Public Policy, Elsevier, Elsevier, vol. 45(1), pages 129-162, December.
  7. James Heckman & Carmen Pages, 2003. "Law and Employment: Lessons from Latin America and the Caribbean," NBER Working Papers 10129, National Bureau of Economic Research, Inc.
  8. William Maloney & Jairo Mendez, 2004. "Measuring the Impact of Minimum Wages. Evidence from Latin America," NBER Chapters, National Bureau of Economic Research, Inc, in: Law and Employment: Lessons from Latin America and the Caribbean, pages 109-130 National Bureau of Economic Research, Inc.
  9. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, Elsevier, vol. 35(1), pages 33-47, January.
  10. Fajnzylber, Pablo & Maloney, William F. & Montes-Rojas, Gabriel V., 2009. "Does Formality Improve Micro-Firm Performance? Quasi-Experimental Evidence from the Brazilian SIMPLES Program," IZA Discussion Papers 4531, Institute for the Study of Labor (IZA).
  11. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 38(1), pages 77-114, March.
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Cited by:
  1. Gaaitzen J. de Vries & Abdul A. Erumban & Marcel P. Timmer & Ilya B. Voskoboynikov & Harry X. Wu, 2011. "Deconstructing The BRICs: Structural Transformation And Aggregate Productivity Growth," HSE Working papers, National Research University Higher School of Economics WP BRP 04/EC/2011, National Research University Higher School of Economics.
  2. Docquier, Frédéric & Müller, Tobias & Naval, Joaquín, 2014. "Informality and Long-Run Growth," IZA Discussion Papers 7883, Institute for the Study of Labor (IZA).
  3. Becker, Dennis, 2014. "Heterogeneous Firms and Informality: The Effects of Trade Liberalization on Labor Markets," Working Papers, Cornell University, Department of Applied Economics and Management 180124, Cornell University, Department of Applied Economics and Management.
  4. Frías, Judith A & Kumler, Todd & Verhoogen, Eric A, 2013. "Enlisting Employees in Improving Payroll-Tax Compliance: Evidence from Mexico," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9622, C.E.P.R. Discussion Papers.
  5. Cravo, Túlio A., 2011. "Are small employers more cyclically sensitive? Evidence from Brazil," Journal of Macroeconomics, Elsevier, Elsevier, vol. 33(4), pages 754-769.

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