Assessing the Impact of Trade Reforms on Informality in Egypt

This paper proposes an empirical investigation of the effect of trade liberalization on informality in Egypt. The literature does not indicate a clear relationship between informality and trade liberalization. While some studies find that it is more profitable to enter the formal sector rather to remain informal when trade openness increases, others argue that trade liberalization may lead to an increase in informality. This effect of trade liberalization on the informal sector has been widely discussed at both empirical and public policy levels but was never tested empirically in Egypt. Thus, combining a microeconomic dataset (the Egyptian Labor Market Panel Survey) with some macroeconomic variables (tariffs), we try to assess to what extent trade reforms affected the informal sector in Egypt. Our main findings show that trade liberalization has indeed decreased informality in Egypt. In fact, trade liberalization (i.e. lower trade costs) implies that some firms will find it more profitable to enter the formal sector rather to remain informal. The least productive informal firms will be forced to exit the industry and only the most productive (formal) firms will export to international markets. Moreover, the degree of labor market flexibility associated to the labor reform of 2003 is likely to be one of the reasons behind this change.