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Informality and Development

Listed author(s):
  • LaPorta, Rafael
  • Shleifer, Andrei

We establish five facts about the informal economy in developing countries. First, it is huge, reaching about half of the total in the poorest countries. Second, it has extremely low productivity compared to the formal economy: informal firms are typically small, inefficient, and run by poorly educated entrepreneurs. Third, although avoidance of taxes and regulations is an important reason for informality, the productivity of informal firms is too low for them to thrive in the formal sector. Lowering registration costs neither brings many informal firms into the formal sector, nor unleashes economic growth. Fourth, the informal economy is largely disconnected from the formal economy. Informal firms rarely transition to formality, and continue their existence, often for years or even decades, without much growth or improvement. Fifth, as countries grow and develop, the informal economy eventually shrinks, and the formal economy comes to dominate economic life. These five facts are most consistent with dual models of informality and economic development.

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File URL: http://dash.harvard.edu/bitstream/handle/1/12343780/171301/informality_may27_abstract.pdf
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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 12343780.

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Date of creation: 2014
Publication status: Published in Journal of Economic Perspectives
Handle: RePEc:hrv:faseco:12343780
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  1. Miguel Jaramillo, 2013. "Is there demand for formality among informal firms? Evidence from microfirms in downtown Lima," Avances de Investigación 0013, Grupo de Análisis para el Desarrollo (GRADE).
  2. Suresh de Mel & David McKenzie & Christopher Woodruff, 2013. "The Demand for, and Consequences of, Formalization among Informal Firms in Sri Lanka," American Economic Journal: Applied Economics, American Economic Association, vol. 5(2), pages 122-150, April.
  3. Erik Hurst & Benjamin Wild Pugsley, 2011. "What Do Small Businesses Do?," NBER Working Papers 17041, National Bureau of Economic Research, Inc.
  4. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
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