What is the Cost of Formality? Experimentally estimating the demand for formalization.
Does reducing the cost of registering firms lead to significant formalization by firms in the informal sector? In spite of moves by many governments to simplify procedures and reduce costs of registration, answering this question has proven difficult because none of the programs, to date, have been implemented in a random fashion. We report on the results of a field experiment which approaches this question from a different angle. We provided incentives to register to randomly selected informal sector firms in Sri Lanka. In our lightest treatment, we offered only information about the registration process and reimbursement for direct registration costs. This treatment induced less than two percent of firms to register. Adding payments of one-half to one month's (median firm's) profit leads to registration of around one-fifth of firms. A larger payment of two month's (median firm's) profit induces half of the firms to register. Among the firms not registering after being offered this larger incentive, most faced issues related to ownership of land. Follow-up surveys 15 and 22 months after the intervention finds some evidence for higher profits and sales among firms which formalized, although this seems largely due to the experiences of a few firms which grew rapidly. Firms which formalized were more likely to advertise and use receipt books, but there were no significant impacts on other channels such as use of bank finance or sales to the government. Formalizing is also found to result in a large increase in trust in the state.
Suresh de Mel; McKenzie, D.; Woodruff, C. What is the Cost of Formality? Experimentally estimating the demand for formalization. World Bank, Washington DC, USA (2011) 31 pp.