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THE INFORMAL SECTOR: AN EQUILIBRIUM MODEL AND SOME EMPIRICAL EVIDENCE FROM BRAZIL

Authors


  • Note: Most of this paper appeared previously as part of our unpublished manuscript The Informal Sector. We thank Joana Monteiro and Juliano Assuncão for helping us with the ECINF dataset and its methodology. We also thank Julio Cacho, Paulo Natenzon, Justinas Pelenis, and Glen Weyl for research assistance. We benefited from comments by seminar participants at several institutions and conferences and especially from conversations with William Maloney, Nicola Persico, and Ken Wolpin. This material is based upon work supported by the National Science Foundation under Award Numbers SES0350770 and SES0718407. Portions of this work were done while José Scheinkman was a Fellow of the John Simon Guggenheim Memorial Foundation.

Áureo de Paula, Department of Economics, University of Pennsylvania, Philadelphia, PA 19104, USA (aureo@sas.upenn.edu).

Abstract

We test implications of a simple equilibrium model of informality using a survey of 48,000+ small firms in Brazil. In the model, agents' ability to manage production differs and informal firms face a higher cost of capital and limitation on size, although these informal firms avoid tax payments. As a result, informal firms are managed by less able entrepreneurs, are smaller, and employ a lower capital–labor ratio. The model predicts that the interaction of an index of observable inputs to entrepreneurial ability and formality is positively correlated with firm size, which we verify in the data. Using the model, we estimate that informal firms in our dataset faced at least 1.3 times the cost of capital of formal firms.

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