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The demand for, and consequences of, formalization among informal firms in Sri Lanka

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  • de Mel, Suresh
  • McKenzie, David
  • Woodruff, Christopher

Abstract

The majority of firms in most developing countries are informal. The authors of this paper conducted a field experiment in Sri Lanka that 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 led to registration of around one-fifth of firms. A larger payment equivalent to two months'median profits induced half the firms to register. The main reasons for not formalizing when offered incentives included issues related to ownership of land and concerns about facing labor taxes in the future. The degree of bureaucracy in the registration process also seems to matter for those with the incentive to register, with response to the incentives higher in Colombo, where the registration process was easier, than in Kandy. Three follow-up surveys, at 15 to 31 months after the intervention, measure the impact of formalizing on these firms. Although mean profits increased, this appears largely due to the experiences of a few firms that grew rapidly, with most firms experiencing no increase in income as a result of formalizing. The authors also find little evidence for most of the channels through which formalization is hypothesized to benefit firms, although formalized firms do advertise more and are more likely to use receipt books. In qualitative interviews owners of formalized firms also feel their businesses have more legitimacy. Finally, formalizing is found to result in a large increase in trust in the state. Their focus is largely on the private costs and benefits of existing firms formalizing. Within their sample they cannot measure broader impacts of formalization on other firms (who may prosper from not having to compete against informal firms not paying taxes), nor impacts of easier formalization on entry of new firms. Nevertheless, our results suggest that although most informal firms do not want to formalize, given the current private costs and benefits of formalizing, policy efforts that lead to relatively modest increases in the net benefits of formalizing would induce a sizeable share of informal firms to formalize.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5991.

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Date of creation: 01 Mar 2012
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Handle: RePEc:wbk:wbrwps:5991

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Keywords: Microfinance; Economic Theory&Research; E-Business; Access to Finance; Debt Markets;

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References

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  1. Suresh de Mel & David McKenzie & Christopher Woodruff, 2008. "Returns to Capital in Microenterprises: Evidence from a Field Experiment," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 123(4), pages 1329-1372, November.
  2. Chang-Tai Hsieh & Peter J Klenow, 2008. "Misallocation and Manufacturing TFP in China and India," 2008 Meeting Papers 121, Society for Economic Dynamics.
  3. 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.
  4. McKenzie, David, 2011. "Beyond baseline and follow-up : the case for more t in experiments," Policy Research Working Paper Series 5639, The World Bank.
  5. Kaplan, David S. & Piedra, Eduardo & Seira, Enrique, 2007. "Entry regulation and business start-ups : evidence from Mexico," Policy Research Working Paper Series 4322, The World Bank.
  6. 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.
  7. Klapper, Leora & Laeven, Luc & Rajan, Raghuram, 2006. "Entry regulation as a barrier to entrepreneurship," Journal of Financial Economics, Elsevier, Elsevier, vol. 82(3), pages 591-629, December.
  8. Marianne Bertrand & Francis Kramarz, 2001. "Does Entry Regulation Hinder Job Creation? Evidence from the French Retail Industry," NBER Working Papers 8211, National Bureau of Economic Research, Inc.
  9. 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, Elsevier, vol. 94(2), pages 262-276, March.
  10. 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, MIT Press, vol. 122(1), pages 209-241, 02.
  11. 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, Elsevier, vol. 88(1), pages 19-31, January.
  12. David Kaplan & Eduardo Piedra & Enrique Seira, 2006. "Are Burdensome Registration Procedures an Important Barrier on Firm Creation? Evidence from Mexico," Discussion Papers, Stanford Institute for Economic Policy Research 06-013, Stanford Institute for Economic Policy Research.
  13. Rafael La Porta & Andrei Shleifer, 2008. "The Unofficial Economy and Economic Development," NBER Working Papers 14520, National Bureau of Economic Research, Inc.
  14. 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, August.
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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. 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).
  2. 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.
  3. 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.
  4. De Giorgi, Giacomo & Rahman, Aminur, 2013. "SME’s registration: Evidence from an RCT in Bangladesh," Economics Letters, Elsevier, Elsevier, vol. 120(3), pages 573-578.
  5. Rafael La Porta & Andrei Shleifer, 2014. "Informality and Development," NBER Working Papers 20205, National Bureau of Economic Research, Inc.
  6. 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).
  7. 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.

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  1. The Demand for, and Consequences of, Formalization among Informal Firms in Sri Lanka (AEJ:AE 2013) in ReplicationWiki

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