MSMEs and Informality: A new employer-employee database for Colombia

In Colombia, as in many other countries, there is a lack of comprehensive and recurring information on business demographics. This paper creates a method to generate a periodic firm-employee database that allows for the first analysis of the entire universe of firms in the country. It also creates a methodology suitable for implementation in countries with limited business information. After excluding self-employment (43% of workers) and agriculture, this paper identifies five stylized facts on business demographics in Colombia: 1. Micro-businesses account for 93% of firms, 31% of workers and 9% of the value added. This granularity can be partially explained by a tax waiver on small businesses. 2. The informality of business (from 30% to 88% under the registration or taxes criteria, respectively) is decreasing in the number of employees. This behavior can be explained because small and unproductive firms cannot afford formality, whereas larger firms find profitable to operate formally. 3. Labor informality is high (71% among firms, and 27% among workers) and also decreasing in the number of amployees. This diminishing trend, that in turn is related to small firms hiring few skilled workers, can be explained by a stronger enforcement on larger firms, plus asymmetric taxes. The after tax relative cost of hiring formally is ten times higher for small companies. 4. The incidence of poverty in micro-business is three times higher than in larger firms. 5. Overall, there are incentives for firms to remain small, but also incentives for small firms to do not use capital and skilled workers, affecting productivity and poverty.