54004 Finance & PSD Impact JUNE 2009 The Lessons from DECRG-FP Impact Evaluations ISSUE 7 The seventh in our impact series summarizes research which arose from research staff working together with operational staff on a World Bank ESW on policies to increase the formality and productivity of firms in Bolivia. It is also illustrative of how an instrumental variables approach can be informative in impact evaluations. Do Marginal Firms in Bolivia Benefit from Formalizing? David McKenzie (with Yaye Seynabou Sakho) The majority of firms in many developing Bank ESW. This survey revealed that 39 countries are informal. The influential view percent of firms without a tax registration of Hernando de Soto, that these informal number didn't even know what one was, firms are potential entrepreneurs hampered while the majority of unregistered firms did by red tape has motivated the Doing not know where they had to register. Business project of measuring and reforming barriers to business registration Identifying the Impact of Registering around the world. And multiple Bank If all firms are fully informed and face the projects and Government efforts are same costs of registering, then any designed to try and encourage firms to comparison of formal and informal firms is become formal. not going to be informative about the effects Underlying these policies is, in part, of formalizing ­ all the firms that it would the notion that formalizing benefits firms, benefit to register would have done so, and giving them more access to credit and all those that it would not benefit would government services, and making them more remain informal. productive. Simple comparisons of formal However, in the Bolivian context the and informal firms, such as those conducted lack of information that many firms have by the McKinsey Global Institute in a about registering provides a reason why number of countries, indeed show formal some firms might register, and other similar firms to be more productive. firms might not. We use this idea to identify But these simple comparisons ignore the impact of registering. the fact that formality is a choice of firms ­ We measured the GPS coordinates of if it is really so beneficial, why don't firms each firm in our survey, and also obtained register of their own accord? the coordinates of the city center, municipal government offices, and tax registration The Bolivian Context office. We use this to measure the distance Bolivia has the highest levels of informality of a firm to the tax registration office, and to in Latin America. While there are several control for the distance to the city center and levels of registration with the Government, to the municipal registration office. This firms understand formality to mean distance to the tax office is then used as an registering for taxes. Clearly paying taxes instrument for formalizing. Intuitively, this involves an easily detected cost to firms. allows us to measure the impact of The main question of interest is whether it formalizing on firms who would register for also has benefits. taxes if they were close enough to the tax A series of focus group surveys and office to have the information and lower a detailed firm survey were carried out in cost of registering, but who otherwise don't urban Bolivia to try and understand the costs register. and benefits for formality as part of a World Do you have a project you want evaluated? DECRG-FP researchers are always looking for opportunities to work with colleagues in the Bank and IFC. If you would like to ask our experts for advice or to collaborate on an evaluation, contact us care of the Impact editor, David McKenzie (dmckenzie@worldbank.org) Formalizing Pays ­ but only for some small, firms among them. This suggests We find that: several directions for policy. 1. The marginal firm who is only informal because of lack of information stands to 1. Better information provision by almost double profits by registering. This Governments on how to register and estimate is robust to a number of controls for more places to do so will likely lead to less possible threats to our identification informality. The IFC and municipal strategy, and suggests big gains to governments had devoted some effort to formalizing. registration of municipal simplification in Bolivia, and we found firms had more 2. However, this gain is only for firms information about this process, with distance with 2 to 5 workers. Smaller firms would to the municipal office not mattering for see profits fall while formalizing ­ and registration. In contrast there had been much large informal firms also lose out by less effort to simplify and explain tax formalizing. Firms which are too small see registration. no benefit from formalizing, they just pay more costs in terms of taxes. Larger firms 2. Yet most informal firms are unlikely to who have managed to stay informal are want to become formal. Our results show likely to have made a conscious choice to do big gains to firms whose lack of knowledge so, and formalizing would also just mean and travel costs prevent them from more taxes. formalizing. The rest of the firms don't stand to gain from formalizing. This accords 3. The benefits of formalizing seem to with the finding that after business mainly be through attracting more registration reform in Mexico, most of the customers, not through access to credit. In new businesses came from new business the focus group interviews firms identified start-up, rather than registration of informal the ability to give tax receipts to consumers businesses (see Impact Note 2). and thereby gain new customers who want these receipts as the main benefit. This is 3. More experimentation is needed over verified in our quantitative work. However, what it takes to get larger informal firms while many firms say access to credit is a to formalize. Owners of larger firms who constraint, few participate in the formal are informal tended to be of higher financial system, and banks do not appear to entrepreneurial ability than formal firm be concerned with tax registration status owners- so they may have figured out ways while granting credit. to avoid inspections and grow their businesses without formalizing. More Policy Implications and Future Directions enforcement on these larger businesses Our findings suggest that registering for along with business development programs taxes would seem to benefit only the which are tied to formalization might get unregistered firms who don't know how to these firms to formalize ­ evaluating register, and only the small, but not too whether this works in practice is a priority. For further reading see: McKenzie, David and Yaye Seynabou Sakho. "Does it pay firms to register for taxes? The impact of formality on firm productivity?, forthcoming, Journal of Development Economics (and also available as World Bank Policy Research Working Paper No. 4449) Recent impact notes are available on our website: http://econ.worldbank.org/programs/finance/impact Impact Note 1: Which Microenterprises have high returns to capital? ­ David McKenzie Impact Note 2: Does Business Registration Reform increase entrepreneurial activity? ­ Miriam Bruhn Impact Note 3: The Promise of Index Insurance ­ Xavier Gine Impact Note 4: Why is More Capital not enough to Grow Female Businesses? ­ David McKenzie Impact Note 5: Valuing Financial Literacy: Evidence from Indonesia ­ Bilal Zia Impact Note 6: Evaluating the Efficiency of a Bankruptcy Reform ­ Xavier Gine and Inessa Love.