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(In)Formal and (Un)Productive: The Productivity Costs of Excessive Informality in Mexico

Matias Busso, Maria Victoria Fazio and Santiago Levy Algazi

No 4047, IDB Publications (Working Papers) from Inter-American Development Bank

Abstract: The laws that regulate relations between firms and workers in Mexico distinguish sharply between salaried and non-salaried workers, and they are at the root of the existence of informality. This paper provides a clear definition of informality, distinguishing it from illegality. Using Mexico's Economic Census, the paper shows that the majority of firms are informal but legal, that there are more small formal firms than large ones, and that some large firms are informal. It also shows that informality and illegality increased in the period 1998-2008. Using a simple model of monopolistic competition to measure the productivity losses due to distortions that misallocate resources, the paper finds that one peso of capital and labor allocated to formal and legal firms is worth 28 percent more than if allocated to illegal and informal firms, and 50 percent more than if allocated to legal and informal firms. The paper concludes arguing that the distortions in the labor market created by informality reduce total factor productivity.

Keywords: Labor Policy; Productivity; Total factor productivity; Informality; Distortions; Misallocation costs (search for similar items in EconPapers)
JEL-codes: D24 O47 L25 (search for similar items in EconPapers)
Date: 2012-08
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