The impact of formalisation on firm productivity and revenue
Formal businesses are more productive than informal ones, but additional studies controlling for self-selection of more productive firms into formality would be helpful to further clarify the link between business registration reform, productivity and revenues.
- De Vries (2010), using a data set of 11,000 firms in Brazil, finds that formal small retailers are on average 65% more productive than their informal counterparts. De Vries suggests that this may be due to the benefits of access to formal credit, public goods such as legal contracts, the ability to advertise and the possibility of increasing the customer base by issuing tax receipts.
- Similarly, a survey of 1,200 formal and informal firms in Ecuador finds that formal firms tend to be more profitable and have higher output per worker, after controlling for various firm, owner and location characteristics (Medvedev and Oviedo, 2015).
- While not focused on formalisation as such, Haltiwanger and Scarpetta (2004) find that new firms which survive tend to grow quickly and increase their profitability, based on census data from 24 countries.
One study investigates the link between business registration and revenue growth in more detail, suggesting that at least in some cases, higher profits can be attributed to formalisation.
- A randomised controlled trial by de Mel, McKenzie and Woodruff (2012) finds that the formalisation of small firms in Sri Lanka is associated with an increase in monthly profits. However, this increase can be attributed to the significant growth of only a few firms, as a result of changing business operations. Qualitative interviews indicate that these were driven by firms’ new formal status, which allowed them, among others, to obtain loans, official licenses and expand their facility.
The impact of firm start-up and formalisation on aggregate productivity and revenues
Lowering entry restrictions, such as high costs to register a business or obtain licences, clearly appears to contribute to higher aggregate productivity, as new firms are encouraged to formalise and create a more competitive market overall.
- A study by Chari (2011) empirically tests this using firm-level data following licence reform in India in 1985. The reform significantly relaxed entry and size constraints for certain manufacturing industries. The result was aggregate productivity growth of 22% in the manufacturing sector, of which 75% could be attributed to the relaxation of entry restraints.
- Conversely, a cross-country study of European firms by Klapper, Laeven and Rajan (2006) finds that, even in naturally high-growth industries, higher market entry regulations are associated with slower productivity growth in incumbent firms.
- One of the reasons for this slow growth may be that, in less-competitive environments, firms have weaker incentives to invest in new technologies. A study by Nicoletti and Scarpetta (2003) estimates that, in a sample of OECD countries, entry liberalisation has a positive impact on productivity due to uptake of new technologies.
The link between business entry regulations and revenues is complex, as more competitive market entrants are likely to earn more, while incumbent businesses may lose out.
- Bruhn (2008) studies the effect of one-stop business registration processes in Mexico and finds the revenue of incumbent business owners decreased by roughly 3% as a result of increased competition from new entrants.
A more productive economy is, however, beneficial for all in the long run. Rising productivity increases output per worker, raises incomes, and stimulates demand. The result is a sustained increase in equilibrium income and overall standard of living.