Financial Frictions and Firm Informality: A General Equilibrium Perspective

By Luis Franjo, Nathalie Pouokam, Francesco Turino

September 25, 2020

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Luis Franjo, Nathalie Pouokam, and Francesco Turino. Financial Frictions and Firm Informality: A General Equilibrium Perspective, (USA: International Monetary Fund, 2020) accessed November 9, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

In this paper we build a model of occupational choice with informal production and progressive income taxation. We calibrate the model to the Brazilian economy to evaluate the impact of removing financial frictions on informality. We find that financial deepening leads to a drop in the size of the informal sector (from 37 percent to 22 percent of official GDP), to an increase in measured TFP (by 4 percent), to an increase in official GDP (by 27 percent), to a decrease in tax evasion (by 17 percent) and to an increase in fiscal revenues (by 15 percent). When assessing the response of this policy at different levels of financial development, we find a non-linear relationship between the credit-to-GDP ratio on the one hand, and either the size of the informal economy, or GDP per capita on the other hand. We test these features with cross-country data and find evidence in favor of both types of non-linearity. We also investigate changes in the income tax progressitivity as an alternative policy and find it to be more effective in countries with a medium to high level of financial markets development.

Subject: Credit, Economic sectors, Economic theory, Financial frictions, Informal economy, Labor, Money, Revenue administration, Self-employment, Tax evasion

Keywords: Credit, Entrepreneurship, Financial frictions, Firms informality, Ghost firm, Informal economy, Informal firm, Informality, Misallocation, Parasite firm, Productivity, Self-employment, Survival firm, Tax evasion, Taxation, WP

Publication Details

Pages:

33
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2020/211
Stock No:

WPIEA2020211
ISBN:

9781513557809
ISSN:

1018-5941

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