The Unofficial Economy and Economic Development

66 Pages Posted: 23 Nov 2008 Last revised: 9 Apr 2009

See all articles by Rafael La Porta

Rafael La Porta

Dartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER)

Andrei Shleifer

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: November 20, 2008

Abstract

In developing countries, informal firms (those that are not registered with the government) account for about half of all economic activity. We consider three broad views of the role of such firms in economic development. According to the romantic view, these firms would become the engine of economic growth if not stopped by government regulation. According to the parasite view, informal firms, by avoiding taxes and regulations, unfairly compete with the more efficient formal firms and, by taking away their market share, undermine economic progress. According to the dual view, informal firms are highly inefficient, do not pose much threat to the formal firms, but also do not contribute to economic growth, which is driven by the efficient formal firms.

Using data from World Bank firm level surveys, we find that informal firms are small and extremely unproductive, compared even to the small formal firms, and especially relative to the larger formal firms. Compared to the informal firms, formal ones are run by much better educated managers. As a consequence, they use more capital, have different customers, market their products, and use more external finance. Hardly any formal firms had ever operated informally. This evidence is inconsistent with the romantic and parasite views, but supports the dual view. In this "Walmart" theory of economic development, growth comes from the creation of the highly productive formal firms. Informal firms keep millions of people alive, but disappear over time.

Keywords: dual economy, productivity, registration

JEL Classification: O17

Suggested Citation

La Porta, Rafael and Shleifer, Andrei, The Unofficial Economy and Economic Development (November 20, 2008). Tuck School of Business Working Paper No. 2009-57. Available at SSRN: https://ssrn.com/abstract=1304760 or http://dx.doi.org/10.2139/ssrn.1304760

Rafael La Porta

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Andrei Shleifer (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-5046 (Phone)
617-496-1708 (Fax)

HOME PAGE: http://www.economics.harvard.edu/~ashleife/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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