Publication: A Helping Hand or the Long Arm of the Law?: Do Carrots or Sticks Work Best for Bringing Informal Firms into the Formal Sector?
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2013-05
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2013-05
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Since 2004, 75 percent of countries have adopted at least one reform making it easier to register a business. Yet, despite these efforts, the majority of firms in most developing countries remain informal. This is of concern to policymakers, who worry that a large stock of informal firms results in a loss in tax revenue, unfair competition for formal firms, and a culture of informality. Much less attention has been given to increasing the costs of remaining informal through better enforcement of existing laws. A field experiment conducted with the State Government of Minas Gerais in the city of Belo Horizonte in Brazil provides an opportunity to test the relative merits of further cost-reduction versus enforcement in formalizing firms. Further experimentation as to how to better improve the process of enforcement of regulations, seems an important area for policy and research efforts going forward.
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“de Andrade, Gustavo Henrique; McKenzie, David; Bruhn, Miriam. 2013. A Helping Hand or the Long Arm of the Law?: Do Carrots or Sticks Work Best for Bringing Informal Firms into the Formal Sector?. Finance PSD Impact;no. 24. The lessons
from DECFP impact evaluations. © World Bank. http://hdl.handle.net/10986/22623 License: CC BY 3.0 IGO.”
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Publication A Helping Hand or the Long Arm of the Law? Experimental Evidence on What Governments Can Do to Formalize Firms(World Bank, Washington, D.C., 2013-05)Many governments have spent much of the past decade trying to extend a helping hand to informal businesses by making it easier and cheaper for them to formalize. Much less effort has been devoted to raising the costs of remaining informal, through increasing enforcement of existing regulations. This paper reports on a field experiment conducted in Belo Horizonte, Brazil, in order to test which government actions work in getting informal firms to register. Firms were randomized to a control group or one of four treatment groups: the first received information about how to formalize; the second received this information and free registration costs along with the use of an accountant for a year; the third group was assigned to receive an enforcement visit from a municipal inspector; while the fourth group was assigned to have a neighboring firm receive an enforcement visit to see if enforcement has spillovers. The analysis finds zero or negative impacts of information and free cost treatments, and a significant but small increase in formalization from inspections. Estimates of the impact of actually receiving an inspection give a 21 to 27 percentage point increase in the likelihood of formalizing. The results show most informal firms will not formalize unless forced to do so, suggesting formality offers little private benefit to them. 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The analysis shows that owners of large firms who have managed to stay informal have higher entrepreneurial ability than formal firm owners, in contrast to the standard view (correct among smaller firms) that informal firm owners have low ability.
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