The Demand for, and Consequences of, Formalization Among Informal Firms in Sri Lanka

37 Pages Posted: 14 Apr 2012

See all articles by Suresh de Mel

Suresh de Mel

University of Peradeniya

David J. McKenzie

World Bank - Development Research Group (DECRG); IZA Institute of Labor Economics

Christopher M. Woodruff

University of California, San Diego (UCSD) - Graduate School of International Relations and Pacific Studies (IRPS)

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Abstract

The majority of firms in most developing countries are informal. We conducted a field experiment in Sri Lanka which provided incentives for informal firms to formalize. Offering only information about the registration process and reimbursement for direct registration costs had no impact on formalization. Adding payments equivalent to one-half to one month's profits for the median firm leads to registration of around one-fifth of firms. A larger payment equivalent to two month's median profits induces half of the firms to register. Among the firms not registering after being offered this larger incentive, many faced issues related to ownership of land. Three follow-up surveys at 15 to 31 months after the intervention measure the impact formalizing has on these firms. Although mean profits increase, this appears largely due to the experiences of a few firms which grew rapidly, with most firms experiencing no increase in income as a result of formalizing. We also find little evidence for most of the channels through which formalization is hypothesized to benefit firms, although formalized firms do advertise more. Finally, formalizing is found to result in a large increase in trust in the state.

Keywords: informality, small enterprises, entrepreneurship

JEL Classification: O17, O12, C93, D21, L26

Suggested Citation

de Mel, Suresh and McKenzie, David John and Woodruff, Christopher, The Demand for, and Consequences of, Formalization Among Informal Firms in Sri Lanka. IZA Discussion Paper No. 6442, Available at SSRN: https://ssrn.com/abstract=2039568

Suresh De Mel (Contact Author)

University of Peradeniya ( email )

University of Peradeniya
Dept of Economics & Statistics
Peradeniya
Sri Lanka
+94 81 2392622 (Phone)

David John McKenzie

World Bank - Development Research Group (DECRG) ( email )

1818 H. Street, N.W.
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Washington, DC 20433
United States

IZA Institute of Labor Economics ( email )

P.O. Box 7240
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Germany

Christopher Woodruff

University of California, San Diego (UCSD) - Graduate School of International Relations and Pacific Studies (IRPS) ( email )

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La Jolla, CA 92093-0519
United States
858-534-0590 (Phone)
858-534-3939 (Fax)

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