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Small Business Economics

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01.01.2010

Informal firms in developing countries: entrepreneurial stepping stone or consolation prize?

verfasst von: John Bennett

Erschienen in: Small Business Economics | Ausgabe 1/2010

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Abstract

The potential dynamic benefits of a firm having the option to adopt informal status are analysed. Informality may be a stepping stone, without which formality may never be achieved. This result is obtained for a broad range of realistic parameter values, suggesting a potential dynamic case for government support of informal firms. Informality may alternatively play a converse role as a consolation prize, with a firm only entering an industry (formally) because it recognizes that if profitability is disappointing, it can switch to informality. However, this result is obtained for a range of parameter values so narrow as to be of no practical significance.

Vorheriger Artikel High-growth entrepreneurial firms in Africa: a quantile regression approach

Nächster Artikel Entrepreneurship and welfare

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Similar arguments can be made with respect to choosing between small and large size even without the formality–informality dimension being included in the model. However, the analysis of these arguments in the context of formality and informality is particularly important because it relates to whether government policy should actively discourage informality.

This advantage may also be interpreted as reflecting the ability of a formal—but not an informal—firm to sell its output to the government, thereby receiving a higher price than for a private sale.

A similar formulation is used by Bennett (2008) to analyse welfare aspects of formality/informality and by Bennett and Estrin (2009) to analyse interactions between formal and informal firms. Other cost/benefits for formal—but not informal—firms that appear in the literature, but which I do not consider, are taxes (Auriol and Warlters 2005), registration costs (Antunes and Cavalcanti 2007) and access to formal finance (Straub 2005) and superior technology (Chong and Gradstein 2007). Also, endogenous growth models have been developed in which higher taxes finance more productive public infrastructure but give an incentive to firms to be informal so as not to pay tax (see, for example, Loayza 1996, Sarte 2000 and Ihrig and Moe 2004).

It is noted by the World Bank (2007, p. 140) that in Mexico new entrants into self-employment are more likely to start their businesses without any employees, testing the waters before they make any significant investment decisions. Self-employment in developing economies is commonly treated as part of the informal sector.

This may occur by transferring the assets for the (formal) firm to set up another (informal) firm under another name.

Although it would be interesting to allow for the possibility that the firm may employ some workers formally and some informally, the model is not suited to examining this issue.

By specifying a larger size for a formal firm than an informal firm, I am implicitly assuming that the risk of discovery and associated penalties are so great if the firm is informal and large, that the entrepreneur never pursues this option. Reformulation of the model explicitly to incorporate this factor would make it more complicated without affecting the basic insights that are obtained.

θ may be understood as output with either the Jovanovic firm-specific interpretation or the Hausmann–Rodrick industry-specific interpretation of uncertainty; with the latter interpretation, however, θ may alternatively be understood as unit price.

The informal firm could be interpreted as involving self-employment, with w being the opportunity cost for the entrepreneur—that is, the market wage that he or she could earn if employed by another firm. But then it would also be necessary to allow for the entrepreneur’s opportunity cost if his or her firm is formal, so presumably w should also be subtracted from the expression for formal profit. Appropriate amendments would then be required throughout our algebra, but the general thrust of the arguments would be unaffected.

Here, \(EV(f)=2(\beta \Uptheta -\bar{w}-k)+E\pi _{2}(f),\) where Eπ₂(f) is given by (Eq. 9); EV(i) = Θ−w−k + Eπ₂(i), where Eπ₂(i) is given by (Eq. 14). These equations also apply for (C2) and (C3).

The ones that are obtained are those for the four furthest right-hand cells of Table 2 for β = 1.1; the three furthest right-hand ones for β = 1.3; the two furthest right-hand ones for β = 1.5 and the far right-hand one for β = 1.7.

For the particular example described for (C2) above, that is, with β = 1.5 and \(w/\bar{w}=0.625,\) it is found that the required range for 2Θ is the same for (C3) as for (C2).

Another possibility is that an informal firm faces a binding constraint on its availability of credit, whereas a formal firm is unconstrained. This would work against both the stepping-stone and consolation-prize arguments.

Recall that, for brevity, we are using the term ‘payoff’ to represent the present value, as of the beginning of t = 1, of the expected profit stream over the two periods in the model.

Ahsan, A., & Pages, C. (2007). Are all labour regulations equal? Assessing the effects of job security, labour dispute, and contract labour laws in India. World Bank policy research working paper 4259. Washington D.C.: World Bank

Amaral, P. S., & Quintin, E. (2006). A competitive model of the informal sector. Journal of Monetary Economics, 53, 1541–1553.CrossRef

Antunes, A. R., & Cavalcanti, T. V. de V. (2007). Start up costs, limited enforcement, and the hidden economy. European Economic Review, 51, 203–224.CrossRef

Auriol, E., & Warlters, M. (2005). Taxation base in developing economies. Journal of Public Economics, 89, 625–646.CrossRef

Banerji, A., & Jain, S. (2007). Quality dualism. Journal of Development Economics, 84, 234–250.CrossRef

Bennett, J. (2008). Formality, informality, and social welfare. IZA discussion paper 3550. Bonn: IZA (Institute for the Study of Labour).

Bennett, J., & Estrin, S. (2009). Entrepreneurial entry in developing economies. In R. Kanbur & J. Svejnar (Eds.), Labour markets and economic development. Abingdon, UK: Routledge.

Chong, A., & Gradstein, M. (2007). Inequality and informality. Journal of Public Economics, 91, 159–179.CrossRef

de Paula, A., & Scheinkman, J. (2008). The informal sector. PIER working paper 08-018. Philadelphia: University of Pennsylvania.

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Jovanovic, B. (1982). Selection and the evolution of industry. Econometrica, 50, 649–670.CrossRef

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Titel: Informal firms in developing countries: entrepreneurial stepping stone or consolation prize?
verfasst von: John Bennett
Publikationsdatum: 01.01.2010
Verlag: Springer US
Erschienen in: Small Business Economics / Ausgabe 1/2010
Print ISSN: 0921-898X
Elektronische ISSN: 1573-0913
DOI: https://doi.org/10.1007/s11187-009-9194-6

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