Informality and institutions

necessarily in the long term.18 In Brazil and Peru, trade liberalization and increased import competition were associated with increases in informality as informal firms exited and formal firms increasingly hired informal workers (Cisneros-Acevedo, forthcoming) or workers increasingly worked informally (Dix-Carneiro and Kovak 2019).

More informality is also associated with lower government revenues and expenditures, less effective public institutions, more burdensome tax and regulatory regimes, and weaker governance (for instance, Dabla-Norris, Gradstein, and Inchauste 2008; Enste and Schneider 1998; World Bank 2019).19

Government revenues and expenditures. On the basis of the various measures of informality, government revenues in EMDEs with above-median informality were, on average, 5-12 percentage points of GDP below those with below-median informality during 2000-18 (figure 4.6). The composition of tax revenues is also tilted toward trade taxes in economies with more pronounced informality, making the tax system less progressive but facilitating tax collection when income underreporting is widespread. Similarly, in EMDEs with more pervasive informality, government expenditures were 5-10 percentage points of GDP lower than in those with less informality.

Such constrained government spending is reflected in more limited provision of government services, contributing to poorer human development outcomes (Gaspar et al. 2019). During 2000-18, EMDEs with above-median informality spent about 2 percent of GDP on health, which was 1 percentage point of GDP lower than in EMDEs with below-median informality (figure 4.6). The average number of pupils per teacher in primary schools was about 35 in EMDEs with above-median informality— significantly higher, by 8 students per teacher, than in EMDEs with below-median informality. Access to medical resources, such as physicians and nurses, was also significantly more limited in EMDEs with a more pervasive informal sector (World Bank 2020a).

Regulatory burdens. Both empirical and theoretical studies suggest that heavier regulatory (or administrative) burdens are associated with greater informality (figure 4.6).20 Over the period 2010-18, the average ease of doing business score for EMDEs with below-median informality (by DGE estimates) was higher by 7 points—two-thirds

18 The changes of informal employment following trade liberalization, conditioning labor market rigidities, are studied in Attanasio, Goldberg, and Pavcnik (2004), Bosch, Goñi-Pacchioni, and Maloney (2012), Goldberg and Pavcnik (2003), Ponczek and Ulyssea (2018), andWorld Bank (2019). 19 Access to the court system can also encourage formal production (Mendicino and Prado 2014; Schneider, Buehn, and Montenegro 2010). 20 For studies that examine the link between informality and regulatory (or administrative) burdens, see Bruhn (2011), de Mel, McKenzie, and Woodruff (2013), Perry et al. (2007), Rocha, Ulyssea, and Rachter (2018), and Ulyssea (2010).