Size Dependent Policies, Informality and Misallocation

Era Dabla-Norris, Laura Jaramillo, Frederico Lima and Alexandre Sollaci

No 2018/179, IMF Working Papers from International Monetary Fund

Abstract: We examine the effect of size-dependent policies in developing economies by focusing on a set of regulations that are applicable to firms with 20 or more formal employees in Peru. Firms can adjust to the regulations by (a) reducing their size, (b) shifting employment composition, or (c) splitting into subunits that fall below the regulatory threshold. We show that these actions are consistent with observed discontinuities in the distributions of firm size and employment composition. We extend the framework proposed by Garicano et al. (2016) to model and estimate the Peruvian economy and perform counterfactual exercises. Size-dependent regulations are costly for the economy, especially in the presence of labor market rigidities, and lead to lower aggregate wages, profits, and output. We also find that access to informal labor does not mitigate the economic impact of the size-dependent regulations, as the increase in informal employment is largely offset by a decline in formal employment.

Keywords: WP; math display; appendix E; size-dependent policies; misallocation; productivity; informality; firm size distribution; salaried employee; profit sharing; medium firm; firm splitting; wage rigidity; firm hire; profits increase; labor cost share; firm owner; size density; third party firm; Wages; Employment; Labor demand; Labor costs (search for similar items in EconPapers)
Pages: 62
Date: 2018-08-02
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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