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Financial Structure, Informality and Development

  • Hernan J Moscoso Boedo


  • Pablo N D’Erasmo


This is a theory of total factor productivity based on measured capital market im- perfections and costs of creating and operating formal sector firms. We develop a firm dynamics model with endogenous formal and informal sectors where firms face a technol- ogy adoption opportunity. The model predicts that countries with a low degree of debt enforcement and high costs of formality are characterized by low allocative efficiency and a large share output produced by low productivity firms in the informal sector. We find that this mechanism is quantitatively important. When frictions are parameterized using the World Bank Doing Business database, the model explains up to 60% of total factor productivity differences between the US and developing economies.

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Paper provided by University of Virginia, Department of Economics in its series Virginia Economics Online Papers with number 374.

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Length: 36 pages
Date of creation: Nov 2009
Date of revision:
Handle: RePEc:vir:virpap:374
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