非正式行业、企业活力和制度参与

WeS )Il1 POLICY RESEARCH WORKING PAPER 198 8 The Informal Sector, Firm The high informality and . mortality and apparent Dynamics, and Institutional stagnation of developing Participation country microfirms are often thought to result from government-induced Alec R. Levenson distortions in labor or product William F. Maloniey markets. A new approach assumes that these informal firms have dynamics similar to firms in industrial countries, and that formality can be thought of as the aecision to participate in societal institutions. This leads to a substantially aifferent vision of the relationship bezween formality and the rature of the small firm that emphasizes the informal firm first as a normal enterprise and second as informal The World Bank Latin America and the Caribbean Poverty Reduction and Economic Management Sector Unit U September 1998  Rfst-Rc_ WOMX 1,8 u2u -in2ry f-indings the iftAnemali microfirm seector is believed to be large, that ensure property rights, pool risk, or enforce accounting for 20-40 percent of employment in many contracts become more important as a firm grows, and dcveloping countries. The literature tends to view the the entrepreneur will be willing to pay for them through sector as the disad-vantaged sector of a seg-nented labor "taxes" in a way that was not the case as a small firm. market, as existing to evade government regulations, or The combination of these assurnptions generates as constrained by lack of access to government services. several of the stylized facts emerging from cross-sectional Levenson and M.aloney offer a unique theoretical data and identified in existing mrdels -informal firms framework to analyze iinformality and microfirm growth tend to) remnailn small and have high rates of mortality5 behavior - one that emphasizes the entrepreneurial and lower productivity -- without recourse to nature of infor-rmal firms and sees informality as a government-induced distortions ia labor or product secondary characteristic. markets. Further, the framework predicts that firms First, they assume that inforinal firms in developing whose cost structures dictate that they should expand countries bave dvnarniics similar to firms in industrial will make the transition to formality as they grow. countries: entrepreneurs have uinobserved, differing cost Using detailed observations fromn Mexico, Levenson structures that determine the&r long-run size and survival and Maloney find their view consistent with patterns of - strocru:i-es rhat tihev can only discover by going into formality and growth of .nicrofirrns. busiress. Secornd, informality can be thought of as a decision to participate in societal instituLticns. Access to mechanisms This paper-a product of the Poverty Reduction and Economic Management Sector Unit, Latin Arn erica and the Caribbean Region--- is part of a larger eZfort in the region to understand the structure of labor markets in developing countries. Copies of the paper are available free from the World Bank. 1818 H Street NWV, Washington, DC 20433. Please contact Tania Gorriez, room 18-102, telephone 202-473-2127, fax 202-522-2119, Internet address tgomezCwvorldbank.org. William Mlalonev rnav be contacted at w^.rmaloneyCworldbank.org. September 1998. (31 pages) 'The Policy Research Tmorki'Zg Paper Series disseninates the findings of work n? progress to encourage the exchange of ideas about ieve/op;fcnio issues. An obiecirve of the series to get the findings out quickly. ev- r, tke presentations are less tkan fully polished. The p Ipess car,y the names Of the authors and should be cited accordingly. Time findiigs, interpretatlons, aeid conclusions expressed in this paper are e.;rir ely those of the authors. iT>eyd o not necessarily represent tre Liew of the W,1'orld Bank, 1ts Exectiive Directors, or the colt,nties lCe rep-scent. Produced bv the Policy Research Dissemnination Center  The Informal Sector, Firm Dynamics and Institutional Participation Alec R. Levenson Milken Institute for Job & Capital Formation 1250 Fourth Street, Second Floor Santa Monica, CA 90401 Telephone: (310) 998-2646 Fax: (310) 998-2626 E-mail: levenson@,mijcf.org William F. Maloney World Bank Telephone: (202)473-7300 E-mail: wmaloneygworldbank.org We would like to thank Agustin Ibarra Almada, Julie Anderson Schaffner, Ragui Assaad, Timothy Besley, Enrique Davila Capalleja, Gina Franco, Gabriel Fuentes, James Hines, Sanjay Jain, Christina Paxson, Elaine Reardon, Stefanie Schmidt, Simon Wilkie, Kristen Willard, Bernard Yeung, Cindy Zoghi and seminar participants at Princeton, USC, UC-Riverside, the Milken Institute, the 1996 Northeast Universities Development Consortium Conference, the 1996 Latin American and Caribbean Economic Association meetings, and the 1996 Western Economic Association Meetings for helpful comments. Gina Franco, Kristin McCullough and Cindy Zoghi provided top notch research support. Our thanks go to the Instituto Nacional de Estadistica, Geografia e Informatica (National Institute of Statistics, Geography and Information) and the Secretaria del Trabajo y Prevision Social (Secretariat of Labor and Social Welfare) for supplying the data. The usual disclaimers apply, with the exception that each of us blames the other for any obvious mistakes, taking full credit for the obscure ones.  I. Introduction ,Crude estimates suggest that the informal production sector is large, accounting for 20 to 50 percent of employment in many developing countries (Portes, 1994). Yet progress towards consensus on the sector's origins, operations and even definition has been hampered by two problems.' First, the lack of comprehensive data has prevented accurately establishing the basic characteristics of informal production beyond conjecture and casual observation. Second, whereas, the literature on informal finance -- i.e. unregulated financial intermediation -- has a broad theoretical underpinning,2 the literature on informal production tends toward ad hoc characterizations and lacks a comparably broad foundation.3 In general, these frameworks rely on an institutional distortion such as a binding minimum wage, evasion of government regulation and taxation, or differences between firms in worker monitoring ability to generate the informal sector.4 This paper makes two contributions. First, it offers systematically collected data on a broad cross-section of urban firms in Mexico with details on compliance with or participation in a number of different societal institutions. The data are derived from a nationally representative sample of all such firms, a significant improvement over pre-existing case study data sets. We are thus able to move beyond anecdotal analysis and establish some definitive stylized facts about irnformal production for the first time. Second, it offers a theoretical framework to motivate the analysis of the data. The 'A large body of literature equates informality with the low-wage, low-productivity segment of a dual labor market (for example, Lewis, 1954, and Harris and Todaro, 1970). An equally sizeable literature equates informality with unregulated self-employment (for example, Hart, 1972, and de Soto, 1989). See Thomas (1992) and Portes (1994) for excellent overviews. Our approach in this paper equates informality and noncompliance with societal norms such as tax obligations, labor protections, census enumerations, business guild participation, etc. In line with both Thomas' and Portes' characterizations, we are concemed with unregulated/umnonitored activities that are ostensibly legal, not those that are truly illegal (criminal). ^ See Besley (1995) for an excellent overview. See Thomas (1992) and Portes (1994). Exceptions include Esfahani and Salehi-Isfahani (1989), Rauch (1991), Loayza (1995), and Banerji and Jain (1996). 4 For the remainder of the paper we will use "informal" exclusively to characterize the production and distribution of goods processes.  approach is unique because it assumes that informal firms behave no differently from small firms in industrialized counties and that no institutional or governmental distortions are required to generate their behavior. To this end the analysis builds on recent mainstream empirical and theoretical research on firm dynamics and extends it to incorporate a general concept of formality. The traditional view of tax and regulatory compliance is that government enforcement is the sole determinant.5 In contrast, we argue that voluntary compliance may arise because the firm derives either direct or complementary benefits from participating in a particular societal institution. Several appealing results emerge. First, the framework is able to generate many of the cross-sectional patterns of firm and worker behavior addressed by existing models and those found in our data. Second, previous approaches have been static: firms are either formal or informal and none transition in equilibrium. However, empirical evidence suggests that developing country (LDC) firms share some of the evolutionary dynamics of their industrialized country counterparts. We show that these dynamics may be important when analyzing informality because they can generate firm characteristics commonly associated with the formality-informality comparison. Moreover, such dynamics imply equilibrium transitions from informality to formality. The nature of the data employed does not permit following individual firms over time and hence precludes rigorous testing of the dynamic predictions. However, we add a new dimension to the theoretical literature and the predicted cross sectional patterns are supported empirically. Finally, the framework can nest many of the existing conceptions of informality, including models that generate the sector through governmental or institutional distortions. I. Formality as participation in civic institutions Different contributions in the literature view compliance with or participation in the institutions of society in seemingly inconsistent ways. Some emphasize firms' desires to evade taxes, regulations or other state controls (for example, Loayza, 1995). Others see the inability to ' For example see Ashenfelter and Smith (1979), Fenn and Veljanovski (1988), Cowell (1990). 2  access institutions, such as those securing property rights, as hampering firm growth (for example, de Soto, 1989). Further there tends to be an assumption that formality is an all or nothing state. We argue that these views are valid only as special cases of a more general and continuous relation between the firm and society. WVe recast the question of formality as the firm's decision of how much to participate in the numerous institutions of civil society: federal and local treasuries, governmental programs such as social security (including pensions and health care), the legal system, the banking system, health inspection, firm censuses, trade organizations, civic organizations, etc. We argue that a minimal degree of participation in some institutions is a necessary input to growth for many firms, and that participation increases with the success of the business. That is, formality can be viewed as a normal input to production: q = f(L,K,P), where L, is labor, K is capital, and P is participation in (a number of different) societal institutions, and all three inputs are complementary. The benefits of formality, while often overlooked, are numerous. They include, but are not limited to:6 1. Enforceable/impersonal contracts and credible signaling. All entrepreneurs have access tD social relationships to enforce implicit contracts among their friends and family, who form a small number of their potential customers and employees. Participation in the legal system is needlessly expensive for transactions with these individuals. Similarly, old age and health insurance may be easily handled by insuring through their mutual extended network of friends and family. Property rights secured by personal ties may be sufficient if investment is minimal. These characteristics of small scale economic transactions are commonly observed in developing countries, as well as in many ethnic enclaves in developed countries. But this mode of operation is constrained by the ability of the entrepreneur to maintain personal relations with all involved parties, a task increasingly unmanageable as firms expand. Legally recognized, enforceable contracts lend credibility to arrangements, permit entry into long term commitments, diminish risk, and can reduce monitoring costs. For example, in a world of imperfect 6 See also de Soto (1989). 3  information, certification that the firmn complies with government health and safety codes may be necessary for firms to attract the largest customer base possible.7 Larger investments require that property rights be secured through the legal system. 2. Access to capital. Informal capital markets (Besley, 1995) may be sufficient to fulfill the firm's external financing needs at low levels of production. However, the small scale and undiversified nature of informal capital markets makes them unsuitable for satisfying the firm's financing needs at larger scales of operation. Growing firms will turn to formal financial intermediaries such as banks. 3. Access to public risk-pooling mechanisms. In order to attract good quality workers the firm may have to offer fringe benefits such as workers compensation, health/unemployment/ disability insurance, and pensions. However, uncertainty over the expected costs of these benefits is high for risk pools with limited numbers of participants, i.e. small firms. Indeed, there is evidence that United States firms backed the introduction of a workers' compensation system to decrease the risk of self-insuring against individual claims (Fishback and Kantor, 1996). Hence, even in the absence of mandatory enrollment laws, a firm may want to enroll in govermment programs that pool risks over a larger population than its own employees. In exchange for this participation, society imposes "taxes" such as reporting requirements,8 fiscal obligations, or social insurance payments. We can conceive of these as comprising an initial fixed cost po that may include information or initial registration costs such as those documented by de Soto (1989), and per period costs, pt, such as taxation that we assume 7 While we frame the empirical discussion in terms of formal versus informalfirms, the concept of informality also applies to subsets of transactions that an ostensibly formal firm may undertake. For example, Palay (1984, 1985) shows that certain transactions between rail-freight shippers and their clients in the United States can be characterized as informal because they occur outside the bounds defined by regulation, and hence are legally unenforceable. In keeping with our motivation here, we would expect such informal transactions to take place primarily between two parties that have a long-standing relationship, even if both parties are large firms and not individual people. A different perspective is offered by Portes (1994) who notes that a portion of economic activity at officially-sanctioned firms often goes unreported; that portion of transactions should be considered informal. 8 This is particularly relevant for bank financing. The firm may have to become registered when it seeks such financing: the govemment may require the bank to report the identity of all its loan recipients for tax or other purposes. 4  for simplicity are the same for all firms.9 We initially assume that the market for formality is voluntary (society levies no costs on firms that choose not to participate in an institution) and that non-payers are perfectly excluded (no free riders). While extreme, these assumptions are consislent with voluntary health or social security programs, and business associations. For example, Chile's self-employed are offered the choice of whether to participate in the state social security program (The Economist, 1996). Just as importantly, our approach highlights an important effect that is not considered by the standard approach in the literatures on tax evasion and regulatory compliance (for example, CowelL, 1990, Fenn and Veljanovski, 1988). These assume that enforcement is the only determinant of compliance because no private benefit is derived from participation: the institution is treated as a strict public good. However, there may be private benefits that make compliance in many public institutions voluntary. In the mandatory workers' compensation system example cited above, the'private benefit of participation outweighed the private cost for many, if not all, firms. De Soto claimed that Peruvian sidewalk vendors sought, not to avoid but, to pay taxes as a way to establish property rights over their precarious business locations. In reality, though the direct private benefit from paying taxes may be zero (again, assuming no enforcement penalties), there may be ancillary benefits that make compliance worthwhile.'0 This very stylized concept of participation can now be embedded in a model of firm dynamics that has become popular in the industrial organization literature." A number of the existing models of the informal sector (e.g Rauch, 1991) are motivated by Lucas' (1978) model 9pt could increase with finn size, i.e. p, = r(q).q. So long as d T/dq < 0, the basic conclusions about participation and firm size and age would not change. O Even in cases where the private benefit of participation does not exceed the private cost, the net private cost may differ substantially, leading to different probabilities of compliance conditional on a given level of enforcernent resources. For example, it may be quite difficult for a frm to undo the effects of a binding minimum wage if ithe compensation package does not include fringe benefits that can be reduced when the wage is raised. In contrast,, it may be easier for the firm to comply with mandated health, pension or other benefits programs by adjusting the wage without significantly altering labor input (for example, Gruber, 1994). Our general point is that the probability of compliance is a positive function of the relative private benefit of participation (net of private costs). " See also Lippman and Rumelt (1982) and Ericson and Pakes (1995). 5  of the size distribution of firms. Lucas argued that there is a distribution of entrepreneurial ability in the population: Those with a sufficiently high level of proficiency become entrepreneurs, while the rest become wage workers. Among the entrepreneurs, those who are more proficient have firms that are larger and/or more successful. However, the model is static: firms do not grow or fail, nor are they born; no one transitions between wage work and self-employment in equilibrium. Jovanovic (1982) addressed these limitations by further assuming that entrepreneurs have uncertainty over their firms' true costs of production: Their precise entrepreneurial ability initially is unknown and can only be learned gradually over time by actually operating a business. Potential entrepreneurs' idiosyncratic entrepreneurial ability, 0, affects their costs, c(qt)xt, through a multiplier xt(0+e