This presentation by Prof Tyler Schipper, University of St Thomas, was made during the discussion on Informal Economy during the 2018 edition of the OECD-IDB Latin American and Caribbean Competition Forum held in Buenos Aires, Argentina on 18-19 September 2018. Find all related materials at the forum website http://oe.cd/laccf.

1. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Formal and Informal Competition:
Prevalence, Intensity, and Policy
Tyler C. Schipper
University of St. Thomas
September 18th
LACCF 2018
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

2. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Introduction
• In 2015, estimates of informal production varied widely from 6.9%
(CHE) to 67% (ZWE) of GDP (Medina and Schneider, 2018).
• The complexity of addressing informality often stems from poor data
and inconsistent definitions.
• The root causes of informality can vary across countries depending
on tax rates, entry costs, enforcement, levels of education, and
cultural norms.
• The sheer size of informal economies suggests an important
balancing act between protecting formal firms from unfair
competition and maximizing overall employment and income.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

3. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Competition
• There has been a long debate about whether informal firms truly
compete against formal firms.
• There have been three views:
• Informal firms gain a competitive advantage by operating informally
(Levy, 2008).
• Informal firms are forced into the informal sector by onerous fixed
costs (De Soto, 1989).
• Informal firms are so unproductive they cannot compete in the
formal sector.
• Informal firms are on average smaller and less productive (La Porta
and Shleifer, 2008; 2014).
• Newer work has documented considerable overlaps in firm size and
productivity, both across and within sectors (Ulyssea, 2018; Allen et
al., 2018; Meghir et al., 2015)
• Reconciling these facts has been one of the main focuses of research
on informality.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

4. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Competition
• The truth is that there are probably informal firms that fit all three
definitions (Ulyssea, 2018).
• This reality has important implications for policy, both in terms of
opportunities and limitations.
• One unambiguous feature of the data is that informality falls with
economic development.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

5. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
WBES Survey Data
• The World Bank Enterprise Survey gives some insight into
competition between formal and informal firms.
• There is broad coverage across middle and lower income countries.
• There are also clear limitations:
• Only formal sector firms with greater than 5 employees are surveyed.
• Self-reported data have well documented drawbacks with respect to
bias and measurement error.
• It contains both binary and intensity measures of informal
competition.
WBES Coverage
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

6. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Informal Competition Globally
Figure: Percentage of Formal Firms that Compete with Informal Firms
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

7. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Latin American and the Caribbean
Figure: Informal Competition in Latin America and the Caribbean
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

8. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Intensity of Competition
Survey Question: How much of an obstacle are the practices of
competitors in informal sector?
Table: Intensity of Informal Competition by Firm Size
Firm Size
Response Small Medium Large
No Obstacle 31.25% 33.37% 39.30%
Minor Obstacle 18.11% 18.96% 20.56%
Moderate Obstacle 20.56% 20.58% 18.72%
Major Obstacle 18.02% 16.13% 13.40%
Very Severe Obstacle 12.07% 10.95% 8.03%
Total Firms 61,621 43,806 24,770
Source: World Bank Enterprise Survey. Author calculations.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

9. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Productivity Overlaps
• Another way that we could evaluate “competition” is the degree to
which formal and informal firms have the same productivity.
• This is particularly important when they operate in the same
industry.
Figure: Productivity Overlaps in India
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

10. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Theoretical Results
Reference
Allen, J., Nataraj, S., Schipper, T.C., 2018. Strict duality and
overlapping productivity distributions between formal and informal firms.
J. Dev. Econ. 135, 534-554.
• The existence of informal firms raises the productivity cut-off for
operating formally.
• The percentage of profits lost due to informal competition is
decreasing in firm productivity and firm size.
• Across industries, there will be some informal firms that are more
productive than formal firms, hence we see productivity overlaps in
the aggregate productivity distributions.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

11. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Empirical Results
• We test some of these theoretical predictions using
establishment-level data from India.
• Our sample covers formal and informal firms in three “snapshots”
with a preferred window of 1999-2001.
• Using previous work by Nataraj (2011), we use estimates of
establishment productivity (TFP) to look at overlaps across and
within industries.
• Important note: the informal firms in the sample are not illegal.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

12. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Empirical - Productivity Overlaps
Figure: Productivity Overlaps and Industry Size across Indian Industries
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

13. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Across Industry Comparisons
Table: Productivity Overlaps and Relationships to Industry Characteristics
Variable Correlation
Informal Percentage 0.18**
Mean TFP -0.29***
Mean Establishment Size -0.42***
Median TFP -0.27***
Median Establishment Size -0.31***
Source: Allen et al., 2018.
• All correlations are relative to a test statistic where larger values
represent less overlap in productivity.
• Therefore, negative correlations in the table imply a positive
relationship between the degree of overlap and each variable.
• More advanced industries have greater overlap, but less informality.
Industry Examples
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

14. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Policy Opportunities and Limitations
Reference
Ulyssea, G., 2018. Firms, informality, and development: theory and
evidence from Brazil. Am. Econ. Rev. 108(8), 2015-2047.
• Ulyssea (2018) has important implications in that it address dual
margins of informality: firm status and labor markets.
• Most importantly, it shows that leading theories of informality are
not opposed.
• This opens the door for policy to addresses unfair competitive
behavior while recognizing its potential limitations.
• His model is calibrated using firm-level data from Brazil.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

15. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Policy Opportunities and Limitations
Figure: Informal Competition in Latin America and the Caribbean
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

16. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Open Questions
• Does data from Brazil and India generalize to other countries?
• How should we understand upstream informal firms that supply
inputs to formal firms?
• Given what we know about the distribution of firm productivity, is
there a socially optimal level of enforcement?
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

17. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
References
• Allen, J., Nataraj, S., and Schipper, T.C. (2018). Strict duality and overlapping
productivity distributions between formal and informal firms. Journal of
Development Economics, 135: 534-554.
• De Soto, H. (1989). The Other Path: The Invisible Revolution in the Third
World. Harper and Row, New York.
• La Porta, R., and Shleifer, A. (2008). The unofficial economy and economic
development. Brookings Papers on Economic Activity, 105(3): 473-522.
• La Porta, R., and Shleifer, A. (2014). Informality and development. Journal of
Economic Perspectives, 28(3): 109-126.
• Levy, S. (2008). Good Intentions, Bad Outcomes: Social Policy, Informality, and
Economic Growth in Mexico. Brookings Institution Press, Washington, D.C.
• Meghir, C., Narita, R., and Robin, J. (2015). Wages and informality in
developing countries. American Economic Review, 105(4): 1509-1546.
• Medina, L., and Schneider, F. (2018). Shadow economies around the world:
What did we learn over the last 20 years?. IMF Working Paper, WP/18/17.
• Nataraj, S. (2011). The impact of trade liberalization on productivity:
Evidencefrom India’s formal and informal manufacturing sectors. Journal of
International Economics, 85(2): 292-301.
• Ulyssea, G. (2018). Firms, informality and development: Theory and evidence
from Brazil. American Economic Review, 108(8): 2015-2047.
Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

18. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
WBES Data
Table: Enterprise Survey Details for Informal Competition Variables
Variable Observations* Countries
Binary (e11) 116,215 141
Intensity (e30) 130,197 141
Source: World Bank Enterprise Surveys.
*Non-missing observations
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Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy

19. Introduction Survey Evidence Productivity Overlaps Policy Considerations Open Questions Supplementary Material
Within-Industry Overlaps
Figure: Overlaps within Industry - Selected Indian Industries
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Tyler C. Schipper Formal and Informal Competition:Prevalence, Intensity, and Policy