PSD Blog - The World Bank Group

An exceedingly simple answer

Oscar Calvo is an economist who works on economic policy for the Latin American and Caribbean region here at the World Bank. He shared with me some interesting research on the determinants of informality in Peru. Oscar and his team conducted a survey of 802 micro and small firms, both informal and formal, and came up with the following chart (below the jump) on the benefits of being registered to pay taxes. (The RUC number is the firm’s tax ID).

Formal firms with informal workers

In my last post, I claimed that “it is common for formal firms to have many informal workers.” How do I know that?

Joyce Sadka and I have been doing some work using data from a labor court in Cuautitlán, which is located just outside of Mexico City. Each data point represents an individual who claimed to have been fired from a formal-sector firm without cause.

As of now we have data on about 2,000 such cases filed in 2002. Most cases settle or are dropped, but 245 cases went all the way to a judge’s ruling. A judge’s ruling hopefully gives us an unbiased look at the facts of the case.

What prevents informal firms from becoming formal?

An earlier post on this blog talked about the benefits to informal or unregistered firms from registering. Using data on informal firms in Côte d’Ivoire, Madagascar and Mauritius (Enterprise Surveys), I argued that a majority of the informal firms believe that registration brings real benefits, especially those associated with better access to finance and markets.

The question that arises then is why don’t firms register? Clearly, there must be some costs or impediments to registering and these costs outweigh the expected gains to firms from registering. I discuss below the sorts of costs that the informal firms associate with becoming formal.

What does formal mean anyway?

I can’t stop thinking about Mohammad’s post on the benefits of formalization.

His post lists nine potential benefits to firms from formalization. You can check out the post to see the complete list. I was particularly interested in the potential benefit of “Better access to workers.”

As a labor economist, I think a lot about the benefits of being a formally-registered worker. In many countries, being formally registered entitles the worker and the worker’s family to government-provided health care. Maybe a pension when the worker retires as well. Firms might find it hard to attract workers if the workers don’t get these benefits.

More on the benefits of formalization

Mohammad Amin gave us a post on new results from a survey of informal firms. Good data from informal firms is indeed an exciting innovation.

I want to focus on his results from Côte d'Ivoire. It turns out that 95% of informal firms in Côte d'Ivoire believe that their access to credit would improve if they became formal firms. This result prompts Mohammad to ask “why don’t firms register then?”

I wanted to take a shot at answering. First, what does access to finance look like in the formal sector? I did a quick analysis using the custom query tool from the Enterprise Surveys web site.

What are the benefits to firms from formalization?

The Enterprise Surveys recently launched an ambitious project to survey informal firms around the globe. Results from three surveys conducted in Ivory Coast, Madagascar and Mauritius are now available. Informal firms surveyed were asked if getting registered would help them or not through better access to finance, raw materials, less bribes, etc. This is an important question given that so much talk on bringing the informal sector within the fold of the formal sector hinges on the supposed benefits of formality but with little hard data to support it. Are these benefits real and how big are they?

The table below shows the percentage of firms that believe that a becoming registered would bring better access to finance, etc. Overall, a substantial number of firms believe that registration provides real benefits - confirming the general perception on this issue. An overwhelming 85.1% of the firms perceive better access to finance and 68% better access to markets from registration. Across countries, benefits are less pronounced in Mauritius relative to the other two countries but still substantial.

More support for good jobs

Some months ago I discussed a paper on the myth of the entrepreneurial middle class. Abhijit Banerjee and Esther Duflo, two of the rockstars in the field of evaluation, argued in the paper that what development requires is "good jobs":

A good job is a steady, well-paid job—a job that allows one the mental space needed to do all those things the middle class does well. This is an idea that economists have often resisted, on the grounds that good jobs may be expensive jobs, and expensive jobs might mean fewer jobs. But if good jobs mean that children grow up in an environment where they are able to make the most of their talents, one might start to think that it may all be worth it.

The idea of a "good job" gets more support from a recent article in Seed Magazine by Sendhil Mullainathan, a professor at Harvard. In Poor Decision Making, he argues:

The financial crisis and migration

With a slowdown in the rich economies (particularly in the housing sector in some countries), might we see large numbers of migrants returning to their home countries? It looks like Poland, at least, is making plans. According to the Polski blog, Poland's government is trying to help:

Polish PM Donald Tusk was in London yesterday. He was supposed to try and convince Poles living here to come back to Poland, by asking “Do you have a return PLan?’ (PL stands for Poland, of course). All that because the Polish government has launched a special site, where Poles living in the UK can get advice regarding moving their lives back to Poland.

Of course, the financial crisis might have the opposite effect in some cases. Trinidadian blogger Coffeewallah remembers the 1980s:

I well remember the eighties and the recession where people dropped their house keys off at banks and fled the country to escape loans.

(Hat tips to Nicholas Laughlin and Veronica Khokhlova of Global Voices.)

China, meet World of Warcraft

The Financial Times today reports that China does U-turn on online money-making. Making 'real' money by trading virtual currencies earned from online gaming was banned two years ago, but it looks like the Chinese government has changed its mind. China will now collect a 20 percent tax on income earned from online gaming.

As I point out in a post on The end of Doha and the World of Warcraft, gold farming and trading in virtual currencies is "largely under the radar of the World Trade Organization and, to some extent, government tax collectors." The FT cites an online contributor with a slightly more poetic take on the issue: "If they successfully implement this tax, I will jump over Mount Everest."

The end of Doha and the World of Warcraft

The Doha trade talks failed this week...and Dani Rodrik asks so what? In his view, the probable gains from this further trade liberalization were not significant. I would add that at least in some sectors, formal trade liberalization is becoming increasingly irrelevant. The internet has created the possiblity for ever greater amounts of trade in services that are largely under the radar of the World Trade Organization and, to some extent, government tax collectors.

One example is that of outsourcing of tutors. India now supplies online tutoring help for many of America's struggling high school students. But tutoring may be just the tip of the iceberg. One estimate has it that gold farming - the practice of earning virtual currency in an online game and exchanging it for real currency - amounts to some US$500 million per year. Gold farmers, many of them based in China, sell the virtual currency to players in rich countries through websites like this one. Perhaps the World of Warcraft is rendering the World Trade Organization a bit less relevant?