Jump to ContentJump to Main Navigation
Show Summary Details
More options …

Open Economics

Editor-in-Chief: Schneider, Friedrich

1 Issue per year

Open Access
See all formats and pricing
More options …

Informality: the Doorstep of the Legal System

Francesco Flaviano Russo
Published Online: 2017-09-02 | DOI: https://doi.org/10.1515/openec-2017-0004


Many entrepreneurs work informally because it is costly to start and run a business legally. Using a dynamic model of industry equilibrium, I show that the costs of the legal system can explain the cross country variability of the size of the informal economy. The model implies that the business start-up costs are more important than taxes and labor market regulations. Small, less productive, entrepreneurs, facing high entry costs, start informally, waiting to become more productive before legalizing. Informality is often the doorstep of the legal system.

Keywords: Informality; Entry; Regulation; Start-up


  • Acemoglu, Daron and Thierry Verdier. 2000. The Choice BetweenMarket Failures and Corruption. American Economic Review 90, 194-211.CrossrefGoogle Scholar

  • Almeida, Rita and Pedro Carneiro. 2005. Enforcement of Labor Regulation, Informal Labor and Firm Performance. World Bank Policy Research Working Paper 3756.Google Scholar

  • Amaral, Pedro S. and Erwan Quintin. 2006. A Competitive Model of the Informal Sector. Journal of Monetary Ecnonomics 53, 1541-1553.Google Scholar

  • Antunes, Antonio R. and Tiago V. de V. Cavalcanti. 2007. Start-Up Costs, Limted Enforcement, and the Hidden Economy. European Economic Review 51, 203-224.CrossrefGoogle Scholar

  • Auriol, Emmanuelle and MichaelWarlters. 2005. Taxation Base in Developing Countries. Journal of Public Economics 89, 625-646.Google Scholar

  • Azuma, Yoshiaki and Herschel I. Grossman. 2002. A Theory of the Informal Sector. NBER working paper 8823.Google Scholar

  • Beck, Thorsten and Asli Demirguc-Kunt. 2006. Small and Medium Sized Enterprises: Access to Finance as a Growth Constrain. Journal of Banking and Finance 30, 2931-2943.Google Scholar

  • Becker, Gary. 1968. Crime and Punishment: an Economic Approach. Journal of Political Economy 76, 169-217.CrossrefGoogle Scholar

  • Bertrand, Marianne and Francis Kramarz. 2002. Does Entry Regulation Hinder Job Creation? Evidence from the French Retail Industry. Quarterly Journal of Economics 107, 1369-1413.Google Scholar

  • Besley, Timothy and Robin Burgess. 2004. Can Labor Regulation Hinder Economic Performance? Evidence from India. Quarterly Journal of Economics 119, 91-134.Google Scholar

  • Blackburn, Keith, Niloy Bose and Salvatore Capasso. 2012. Tax Evasion, the Underground Economy and Financial Development. Journal of Economic Behavior & Organization 83: 243-253.CrossrefGoogle Scholar

  • Blanchard, Olivier and Francesco Giavazzi. 2003. Macroeconomic Effects of Regulation and Deregulation in Goods and Labor Markets. Quarterly Journal of Economics 118, 879-907.CrossrefGoogle Scholar

  • Botero, Juan C., Simeon Djankov, Rafael LaPorta, Florencio Lopez-De-Silanes and Andrei Shleifer. 2004. The Regulation of Labor. Quarterly Journal of Economics 119, 1339-1382.Google Scholar

  • Busato, Francesco and Bruno Chiarini. 2004. Market and Underground Activities in a Two-Sector Dynamic Equilibrium Model. Economic Theory 400: 1-31.Google Scholar

  • Capasso, Salvatore and Tullio Jappelli. 2013. Financial Development and the Underground Economy Journal of Development Economics 101, 167-178Google Scholar

  • Caselli, Francesco and Nicola Gennaioli. 2008. Economics and Politics of Alternative Institutional Reforms. Quarterly Journal of Economics 123, 1197-1250.Google Scholar

  • Choi, Jay Pil and Marcel P. Thum. 2005. Corruption and the Shadow Economy. International Economic Review 46, 817-836.CrossrefGoogle Scholar

  • Dabla-Norris, Era, Mark Gradstein and Gabriela Inchauste. 2008. What Causes Firms to Hide Output? The Determinants of Informality. Journal of Development Economics 85, 1-27.Google Scholar

  • Davis, Steven J. and John Haltiwanger. 1992. Gross Job Creation, Gross Job Destruction and Employment Reallocation. Quarterly Journal of Economics 107, 819-863.Google Scholar

  • Davis, Steven J. and Henrekson, M. 2004. Tax Effects on Work Activity, Industry Mix and Shadow Economy Size: Evidence from Rich Country Comparisons. NBER Working paper 10509.Google Scholar

  • De Paula, Aureo and Jose A. Scheinkman. 2008. The Informal Sector. Penn Institute for Economic Research working paper 08-018.Google Scholar

  • D’Erasmo, Pablo N. and Moscoso Boedo Hernan J. 2012. Financial Structure, Informality and Development. Journal of Monetary Economics 59, 286-302.Google Scholar

  • De Soto, Hernando 1989. The Other Path. New York: Harper and Row. Google Scholar

  • Dessy, Sylvain and Stephane Pallage. 2003. Taxes, Inequality and the Size of the Informal Sector. Journal of Development Economics 70, 225-233.CrossrefGoogle Scholar

  • Djankov, Simeon, Rafael LaPorta, Florencio Lopez-De-Silanes and Andrei Shleifer. 2002. The Regulation of Entry. Quarterly Journal of Economics 117, 1-37.Google Scholar

  • Djankov, Simeon, Rafael LaPorta, Florencio Lopez-De-Silanes and Andrei Shleifer. 2003. Courts. Quarterly Journal of Economics 118, 453-517.CrossrefGoogle Scholar

  • Dunne, Timothy, Roberts, Mark J. and Larry Samuelson. 1989. The Growth and Failure of U. S. Manufacturing Plants. Quarterly Journal of Economics 104, 671-698.Google Scholar

  • Estrin, Saul and Tomasz Mickiewicz. 2012. Shadow Economy and Entrepreneurial Entry. Review of Development Economics 102, 559-578.CrossrefGoogle Scholar

  • Evans, David S. 1987. Tests of Alternative Theories of Firm Growth. Journal of Political Economy 95, 657-674.Google Scholar

  • Friedman, Eric, Simon Johnson, Daniel Kaufmann and Pablo Zoido-Lobaton. 2000. Dodging the Grabbing Hand: The Determinants of Unofficial Activity in 69 Countries. Journal of Public Economics 76, 459-493.Google Scholar

  • Fugazza, Marco and Jean-Francois Jacques. 2003. Labor Market Institutions, Taxation and the Underground Economy. Journal of Public Economics 88, 395-418.Google Scholar

  • Gerxhani, Klarita. 2004. The Informal Sector in Developed and Less Developed Countries: A Literature Survey. Public Choice 120, 267-300.Google Scholar

  • Giles, David E.A. 1999. Measuring the Hidden Economy: Implications for Econometric Modeling. The Economic Journal 109, 370-380.Google Scholar

  • Hirschman, Albert O. 1970. Exit, Voice and Loyalty. Cambridge: Cambridge University Press.Google Scholar

  • Hopenhayn, Hugo 1992. Entry, Exit and Firm Dynamics in Long Run Equilibrium. Econometrica 60, 1127-1150.CrossrefGoogle Scholar

  • Hopenhayn, Hugo and Richard Rogerson. 1993. Job Turnover and Policy Evaluation: A Genaral Equilibrium Analysis. Journal of Political Economy 101, 915-938.Google Scholar

  • Jovanovic, Boyan 1982. Selection and the Evolution of Industry. Econometrica 50, 649-670.CrossrefGoogle Scholar

  • Johnson, Simon, Daniel Kaufmann, D. and Andrei Shleifer. 1997. The Unofficial Economy in Transition. Brooking Papers on Economic activity, 159-221.Google Scholar

  • Johnson, Simon, Daniel Kaufmann and Pablo Zoido-Lobaton. 1998. Regulatory Discretion and the Unofficial Economy. American Economic Review Papers and Proceedings 88, 387-392.Google Scholar

  • Klapper, Leora, Luc Laeven and Raghuram Rajan. 2006. Entry Regulation as a Barrier to Entrepreneurship. Journal of Financial Economics 82, 591-629.CrossrefGoogle Scholar

  • Koreshkova, Tatyana A. 2006. A Quantitative Analysis of Inflation as a Tax on the Underground Economy. Journal of Monetary Economics 53, 773-796.Google Scholar

  • Lacko’,Maria. 1999. Hidden Economy and Unknown Quantity? Comparative Analysis of Hidden Economies in Transition Countries. Univ. of Linz Working Paper.Google Scholar

  • La Porta, Rafael and Andrei Shleifer. 2008. The Unofficial Economy and Economic Development. Brookings Papers on Economic Activity 2008, 275-352.Google Scholar

  • Lemieux, Thomas, Bernard Fortin and Pierre Frechette. 1994. The Effect of Taxes on Labor Supply in The Underground Economy. American Economic Review 84, 231-254.Google Scholar

  • Loayza, Norman. 1996. The Economics of the Informal Sector: a Simple Model and Some Empirical Evidence from Latin America. Carnagie-Rochester Series on Public Policy 45, 129-162.Google Scholar

  • Maloney, William. 2004. Informality Revisited. World Development 32, 1159-1178.CrossrefGoogle Scholar

  • OECD. 2003. Measuring the Non Observed Economy: a Handbook. Paris: OECD.Google Scholar

  • Ordonez, Julio C. L. 2014. Tax Collection, the Informal Sector, and Productivity. Review of Economic Dynamics 17, 262-286.CrossrefGoogle Scholar

  • Prado, Mauricio. 2011. Government Policy in the Formal and Informal Sectors. European Economic Review 55, 1120-1136.CrossrefGoogle Scholar

  • Sarte, Pierre-Daniel G. 2000. Informality and Rent Seeking Bureaucracies in a Model of Long Run Growth. Journal of Monetary Economics 46, 173-197.CrossrefGoogle Scholar

  • Schneider, Friedrich. 2004. Shadow Economies Around the World: What Do We Really Know? European Journal of Political Economy 21, 598-642.CrossrefGoogle Scholar

  • Schneider, Friedrich and Dominik H. Enste. 2000. Shadow Economies: Size, Causes and Consequences. Journal of Economic Literature 38, 77-114.Google Scholar

  • Straub, Stephane. 2005. Informal Sector: the Credit Market Channel. Journal of Development Economics 78, 299-321.CrossrefGoogle Scholar

  • Tanzi, Vito 1983. The Underground Economy in United States: Annual Estimates 1930-1980. IMF staff paper 30, 283-305.Google Scholar

About the article

Received: 2017-02-17

Accepted: 2017-07-11

Published Online: 2017-09-02

Published in Print: 2018-06-01

Citation Information: Open Economics, Volume 1, Issue 1, Pages 49–70, ISSN (Online) 2451-3458, DOI: https://doi.org/10.1515/openec-2017-0004.

Export Citation

© 2017 Francesco Flaviano Russo, published by De Gruyter Open. This work is licensed under the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 License. BY-NC-ND 4.0

Comments (0)

Please log in or register to comment.
Log in