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Misallocation, Informality, and Human Capital

  • Hernan J. Moscoso-Boedo

    ()

  • Pablo N. D’Erasmo

    ()

We develop a theory of total factor productivity to understand differences in pro- ductivity and human capital across countries. In our model, firms face capital market imperfections and costs of operating in the formal sector. Formal firms have a larger set of production opportunities and the ability to employ skilled workers, but informal firms can avoid the costs of formalization. These firm-level distortions give rise to endogenous formal and informal sectors and, more importantly, affect the demand for skilled workers. The model predicts that countries with a low degree of debt enforcement and high costs of formalization are characterized by low allocative efficiency and a larger informal sector, lower measured TFP, and lower stocks of skilled workers. We find that this mechanism plays an important role in generating the differences observed between the US and de- veloping countries in the human capital stock. Moreover, formal sector entry costs and financial frictions are complementary and their joint effect is the main driver of the dif- ferences between the US and developing countries in terms of human capital, informality, and TFP. The complementarity effect is generated by the introduction of skilled workers, which increases the labor substitution incentives, which in turn moves the firm closer to the financial constraint.

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File URL: http://www.virginia.edu/economics/RePEc/vir/virpap/papers/virpap401.pdf
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Paper provided by University of Virginia, Department of Economics in its series Virginia Economics Online Papers with number 401.

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Length: 44 pages
Date of creation: Feb 2012
Date of revision:
Handle: RePEc:vir:virpap:401
Contact details of provider: Web page: http://www.virginia.edu/economics/home.html

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  1. Miriam Bruhn, 2011. "License to Sell: The Effect of Business Registration Reform on Entrepreneurial Activity in Mexico," The Review of Economics and Statistics, MIT Press, vol. 93(1), pages 382-386, February.
  2. Francisco J. Buera & Joseph Kaboski & Yongseok Shin, 2009. "Finance and Development: A Tale of Two Sectors," NBER Working Papers 14914, National Bureau of Economic Research, Inc.
  3. Cristina Arellano & Yan Bai & Jing Zhang, 2009. "Firm dynamics and financial development," Staff Report 392, Federal Reserve Bank of Minneapolis.
  4. Laura Alfaro & Andrew Charlton & Fabio Kanczuk, 2008. "Plant-Size Distribution and Cross-Country Income Differences," NBER Working Papers 14060, National Bureau of Economic Research, Inc.
  5. Levon Barseghyan & Riccardo DiCecio, 2009. "Entry costs, misallocation, and cross-country income and TFP differences," Working Papers 2009-005, Federal Reserve Bank of St. Louis.
  6. D'Erasmo, Pablo N. & Moscoso Boedo, Hernan J., 2012. "Financial structure, informality and development," Journal of Monetary Economics, Elsevier, vol. 59(3), pages 286-302.
  7. Rauch, James E., 1991. "Modelling the informal sector formally," Journal of Development Economics, Elsevier, vol. 35(1), pages 33-47, January.
  8. Guillermo E. Perry & William F. Maloney & Omar S. Arias & Pablo Fajnzylber & Andrew D. Mason & Jaime Saavedra-Chanduvi, 2007. "Informality : Exit and Exclusion," World Bank Publications, The World Bank, number 6730, August.
  9. Hernan Moscoso Boedo & Toshihiko Mukoyama, 2012. "Evaluating the effects of entry regulations and firing costs on international income differences," Journal of Economic Growth, Springer, vol. 17(2), pages 143-170, June.
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