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The informal sector, firm dynamics, and institutional participation

Author

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  • Levenson, Alec R.
  • Maloney, William F.

Abstract

The informal microfirm sector is believed to be large, accounting for 20-40 percent of employment in many developing countries. The literature tends to view the sector as the disadvantaged sector of a segmented labor market, as existing to evade government regulations, or as constrained by lack of access to government services. The authors offer a unique theoretical framework to analyze informality and microfirm growth behavior -- one that emphasizes the entrepreneurial nature of informal firms and sees informality as a secondary characteristic. First, they assume that informal firms in developing countries have dynamics similar to firms in industrial countries: entrepreneurs have unobserved, differing cost structures that determine their long-run size and survival -- structures that they can only discover by going into business. Second, informality can be thought of as a decision to participate in societal institutions. Access to mechanisms that ensure property rights, pool risk, or enforce contracts become more important as a firm grows, and the entrepreneur will be willing to pay for them through"taxes"in a way that was not the case as a small firm. The combination of these assumptions generates several of the stylized facts emerging from cross-sectional data and identified in existing models -- informal firms tend to remain small and have high rates of mortality, and lower productivity -- without recourse to government-induced distortions in labor or product markets. Further, the framework predicts that firms whose cost structures dictate that they should expand will make the transition to formality as they grow. Using detailed observations from Mexico, the authors find their view consistent with patterns of formality and growth of microfirms.

Suggested Citation

  • Levenson, Alec R. & Maloney, William F., 1998. "The informal sector, firm dynamics, and institutional participation," Policy Research Working Paper Series 1988, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1988
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Xavier Joutard & Luis A.I. Sagaon Teyssier, 2006. "Unemployment and employment dynamics in the Mexican segmented labour market," Working Papers halshs-00410460, HAL.
    2. James R. Tybout, 2000. "Manufacturing Firms in Developing Countries: How Well Do They Do, and Why?," Journal of Economic Literature, American Economic Association, pages 11-44.
    3. Esther K. Ishengoma & Robert Kappel, 2006. "Economic Growth and Poverty: Does Formalisation of Informal Enterprises Matter?," GIGA Working Paper Series 20, GIGA German Institute of Global and Area Studies.
    4. García Cruz Gustavo Adolfo, 2008. "Informalidad regional en Colombia. Evidencia y Determinantes," REVISTA DESARROLLO Y SOCIEDAD, UNIVERSIDAD DE LOS ANDES-CEDE, February.
    5. Arias, Omar & Blom, Andreas & Bosch, Mariano & Cunningham, Wendy & Fiszbein, Ariel & Lopez Acevedo, Gladys & Maloney, William & Saavedra, Jaime & Sanchez-Paramo, Carolina & Santamaria, Mauricio & Siga, 2005. "Pending issues in protection, productivity growth, and poverty reduction," Policy Research Working Paper Series 3799, The World Bank.
    6. Jäckle, Annette E & Li, Carmen A, 2003. "Firm Dynamics and Institutional Participation: A Case Study on Informality of Micro-Enterprises in Peru," Economics Discussion Papers 3620, University of Essex, Department of Economics.
    7. Cano-Urbina, Javier, 2015. "The role of the informal sector in the early careers of less-educated workers," Journal of Development Economics, Elsevier, vol. 112(C), pages 33-55.
    8. Cunningham, Wendy V & Maloney, William F, 2001. "Heterogeneity among Mexico's Microenterprises: An Application of Factor and Cluster Analysis," Economic Development and Cultural Change, University of Chicago Press, vol. 50(1), pages 131-156, October.
    9. 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).
    10. Suzanne Duryea & Olga Lucia Jaramillo & Carmen Pagés-Serra, 2003. "Los mercados laborales latinoamericanos en los años 90: descifrar la década," Research Department Publications 4332, Inter-American Development Bank, Research Department.
    11. Fajnzylber, Pablo & Maloney, William F. & Montes-Rojas, Gabriel V., 2011. "Does formality improve micro-firm performance? Evidence from the Brazilian SIMPLES program," Journal of Development Economics, Elsevier, vol. 94(2), pages 262-276, March.
    12. Suzanne Duryea & Olga Lucia Jaramillo & Carmen Pagés-Serra, 2003. "Latin American Labor Markets in the 1990s: Deciphering the Decade," Research Department Publications 4331, Inter-American Development Bank, Research Department.
    13. Maloney, William F., 1998. "Are labor markets in developing countries dualistic?," Policy Research Working Paper Series 1941, The World Bank.
    14. Siba, Eyerusalem, 2015. "Returns to Physical Capital in Ethiopia: Comparative Analysis of Formal and Informal Firms," World Development, Elsevier, vol. 68(C), pages 215-229.
    15. Esther K. Ishengoma & Robert Kappel, 2008. "Business Constraints and Growth Potential of Micro and Small Manufacturing Enterprises in Uganda," GIGA Working Paper Series 78, GIGA German Institute of Global and Area Studies.
    16. José Ignacio Uribe García & Carlos Humberto Ortíz Quevedo, 2004. "Una Propuesta De Conceptualización Y Medición Del Sector Informal," DOCUMENTOS DE TRABAJO-CIDSE 003720, UNIVERSIDAD DEL VALLE - CIDSE.

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