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The Informal Sector: An Equilibrium Model and Some Empirical Evidence from Brazil

  • Aureo de Paula

    ()

    (Department of Economics, University of Pennsylvania)

  • Jose A. Scheinkman

    ()

    (Department of Economics, Princeton University)

We test implications of a simple equilibrium model of informality using a survey of 48,000+ small firms in Brazil. In the model, agent's ability to manage production differ and informal firms face a higher cost of capital and limitation on size, although these informal firms avoid tax payments. As a result, informal firms are managed by less able entrepreneurs, are smaller and employ a lower capital-labor ratio. When education is an imperfect proxy for ability, the model predicts that the interaction of the manager's education and formality is positively correlated with firm size. Using the model, we estimate that informal firms in our dataset faced at least 1.3 times the cost of capital of formal firms.

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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 09-044.

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Length: 30 pages
Date of creation: 02 Dec 2009
Date of revision:
Handle: RePEc:pen:papers:09-044
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  1. Dominik H. Enste & Friedrich Schneider, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March.
  2. Maloney, William F. & Nunez, Jairo & Cunningham, Wendy & Fiess, Norbert & Montenegro, Claudio & Murrugarra, Edmundo & Santamaria,Mauricio & Sepulveda, Claudia, 2001. "Measuring the impact of minimum wages : evidence from Latin America," Policy Research Working Paper Series 2597, The World Bank.
  3. �ureo de Paula & Jose A. Scheinkman, 2010. "Value-Added Taxes, Chain Effects, and Informality," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(4), pages 195-221, October.
  4. Stephane Straub, 2004. "Informal Sector: The Credit Market Channel," ESE Discussion Papers 101, Edinburgh School of Economics, University of Edinburgh.
  5. Fajnzylber, Pablo & Maloney, William F. & Montes-Rojas, Gabriel V., 2009. "Does Formality Improve Micro-Firm Performance? Quasi-Experimental Evidence from the Brazilian SIMPLES Program," IZA Discussion Papers 4531, Institute for the Study of Labor (IZA).
  6. James J. Heckman & Carmen Pagés, 2004. "Law and Employment: Lessons from Latin America and the Caribbean," NBER Books, National Bureau of Economic Research, Inc, number heck04-1.
  7. Loayza, Norman A., 1997. "The economics of the informal sector : a simple model and some empirical evidence from Latin America," Policy Research Working Paper Series 1727, The World Bank.
  8. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  9. 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.
  10. Gabriela Inchauste & Mark Gradstein & Era Dabla-Norris, 2005. "What Causes Firms to Hide Output? the Determinants of Informality," IMF Working Papers 05/160, International Monetary Fund.
  11. Fortin, Bernard & Marceau, Nicolas & Savard, Luc, 1997. "Taxation, wage controls and the informal sector," Journal of Public Economics, Elsevier, vol. 66(2), pages 293-312, November.
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