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Misallocation, informality, and human capital: Understanding the role of institutions

D׳Erasmo, Pablo N., Hernan Moscoso Boedo and Asli Senkal ()
Authors registered in the RePEc Author Service: Pablo N. D'Erasmo ()

Journal of Economic Dynamics and Control, 2014, vol. 42, issue C, 122-142

Abstract: The aim of this paper is to quantify the role of formal-sector institutions in shaping the demand for human capital and the level of informality. We propose a firm dynamics model where firms face capital market imperfections and costs of operating in the formal sector. Formal firms have a larger set of production opportunities and the ability to employ skilled workers, but informal firms can avoid the costs of formalization. These firm-level distortions give rise to endogenous formal and informal sectors and, more importantly, affect the demand for skilled workers. The model predicts that countries with a low degree of debt enforcement and high costs of formalization are characterized by relatively lower stocks of skilled workers, larger informal sectors, low allocative efficiency, and measured TFP. Moreover, we find that the interaction between entry costs and financial frictions (as opposed to the sum of their individual effects) is the main driver of these differences. This complementarity effect derives from the introduction of skilled workers, which prevents firms from substituting labor for capital and in turn moves them closer to the financial constraint.

Keywords: Financial structure; Informal sector; Productivity; Policy distortions; Human capital (search for similar items in EconPapers)
JEL-codes: D24 E26 J24 L11 O16 O17 (search for similar items in EconPapers)
Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:42:y:2014:i:c:p:122-142

DOI: 10.1016/j.jedc.2014.03.009

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Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok

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