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


  • 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. The model predicts that the interaction of an index of observable inputs to entrepreneurial ability and formality is positively correlated with firm size, which we verify in the data. Using the model, we estimate that informal firms in our dataset faced at least 1.3 times the cost of capital of formal firms.

Suggested Citation

  • Aureo de Paula & Jose A. Scheinkman, 2009. "The Informal Sector: An Equilibrium Model and Some Empirical Evidence from Brazil, Second Version," PIER Working Paper Archive 10-024, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 26 Jul 2010.
  • Handle: RePEc:pen:papers:10-024

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    References listed on IDEAS

    1. Dabla-Norris, Era & Gradstein, Mark & Inchauste, Gabriela, 2008. "What causes firms to hide output? The determinants of informality," Journal of Development Economics, Elsevier, vol. 85(1-2), pages 1-27, February.
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    Cited by:

    1. Araujo, Luis Fernando Oliveira de & Ponczek, Vladimir Pinheiro, 2012. "Informal wages in an economy with active labor courts," Textos para discussão 294, FGV/EESP - Escola de Economia de São Paulo, Getulio Vargas Foundation (Brazil).

    More about this item


    Informal Sector; Tax Avoidance; Brazil;

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
    • K4 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior

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