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Informality and Regulations: What Drives Firm Growth?

  • Era Dabla-Norris
  • Gabriela Inchauste

The paper relies on a rich firm-level data set on transition economies to examine the role of informality as an important channel through which regulatory and other policy constraints affect firm growth. We find that firms reduce their formal operations with a higher tax and regulatory burden, but increase it with better enforcement quality. In terms of firm growth, we find a differential impact of regulatory burden and enforcement quality on formal and informal firms. In particular, we find that growth in formal firms is negatively affected by both tax and financing constraints, while these constraints are insignificant for growth in informal firms. Moreover, formal firm growth improves with better enforcement as measured by fair and impartial courts, while informal firm growth is constrained by organized crime, pointing to their inability to take full advantage of the legal and judicial systems. Finally, when we look at country-wide institutions, we find that higher regulatory burden reduces firm growth. An interactive term between a country-wide measure of the rule of law and a proxy for formality suggests that better enforcement quality dampens the relatively weaker growth in formal firms.

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Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/112.

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Length: 26
Date of creation: 01 May 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/112
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  1. Schneider, Friedrich G., 2007. "Shadow economies and corruption all over the world: what do we really know?," Economics Discussion Papers 2007-9, Kiel Institute for the World Economy.
  2. Djankov, Simeon & La Porta, Rafael & Shleifer, Andrei & Lopez de Silanes, Florencio, 2001. "The regulation of entry," Policy Research Working Paper Series 2661, The World Bank.
  3. Maloney, William, 2003. "Informality revisited," Policy Research Working Paper Series 2965, The World Bank.
  4. Straub, Stéphane, 2005. "Informal sector: The credit market channel," Journal of Development Economics, Elsevier, vol. 78(2), pages 299-321, December.
  5. Juan Botero & Simeon Djankov & Rafael Porta & Florencio C. Lopez-De-Silanes, 2004. "The Regulation of Labor," The Quarterly Journal of Economics, MIT Press, vol. 119(4), pages 1339-1382, November.
  6. Áureo de Paula & José A. Scheinkman, 2007. "The Informal Sector," NBER Working Papers 13486, National Bureau of Economic Research, Inc.
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  8. Rajan, Raghuram G & Zingales, Luigi, 1998. "Financial Dependence and Growth," American Economic Review, American Economic Association, vol. 88(3), pages 559-86, June.
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  11. Friedrich Schneider & Robert Klinglmair, 2004. "Shadow Economies around the World: What Do We Know?," CESifo Working Paper Series 1167, CESifo Group Munich.
  12. Johnson, Simon & McMillan, John & Woodruff, Christopher, 1999. "Why do Firms Hide? Bribes and Unofficial Activity After Communism," CEPR Discussion Papers 2105, C.E.P.R. Discussion Papers.
  13. Klapper, Leora & Laeven, Luc & Rajan, Raghuram G, 2004. "Business Environment and Firm Entry: Evidence from International Data," CEPR Discussion Papers 4366, C.E.P.R. Discussion Papers.
  14. Mihir Desai & Paul Gompers & Josh Lerner, 2003. "Institutions, Capital Constraints and Entrepreneurial Firm Dynamics: Evidence from Europe," NBER Working Papers 10165, National Bureau of Economic Research, Inc.
  15. Loayza, Norman V. & Oviedo, Ana Maria & Serven, Luis, 2005. "Regulation and macroeconomic performance," Policy Research Working Paper Series 3469, The World Bank.
  16. repec:reg:rpubli:271 is not listed on IDEAS
  17. Thorsten Beck & Asli Demirgüç-Kunt & Vojislav Maksimovic, 2005. "Financial and Legal Constraints to Growth: Does Firm Size Matter?," Journal of Finance, American Finance Association, vol. 60(1), pages 137-177, 02.
  18. Loayza, Norman V. & Oviedo, Ana Maria & Serven, Luis, 2005. "The impact of regulation on growth and informality - cross-country evidence," Policy Research Working Paper Series 3623, The World Bank.
  19. Stock, James H & Wright, Jonathan H & Yogo, Motohiro, 2002. "A Survey of Weak Instruments and Weak Identification in Generalized Method of Moments," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(4), pages 518-29, October.
  20. 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, vol. 76(3), pages 459-493, June.
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