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Formal Credit and Informal jobs: Micro evidence from Brazil. Luis Cat ã o Carmen Pagés M. Fernanda Rosales Feb 2009. Road Map. Introduction Prima facie evidence Econometric results
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Formal Credit and Informal jobs: Micro evidence from Brazil Luis Catão Carmen Pagés M. Fernanda Rosales Feb 2009
Road Map • Introduction • Prima facie evidence • Econometric results • Links with Productivity (very preliminary) • Conclusion
Introduction • Formality is an optimizing decision of firms based on benefits and costs of being formal. • However informality may have important costs for aggregate welfare and productivity. • Increased supply of credit increases opportunity cost of being informal • If given only to formal firms.
Introduction II • Brazil is an interesting case to look at because improved macroeconomic conditions have led to a substantial increase in the aggregate supply of credit. • Plus has a rich household survey dataset that has not been used to look at links between formal credit and job informality. • Key question we ask: to what extent increased supply of credit has led to higher formality, controlling for other factors.
Introduction III • Increase formality may be driven by: • Informal firms go formal (“within”) • Formal firms that hire informal workers stop doing so and/or formalize existing ones (“within”) • Formal firms expand faster and crowd out informal firms (“between”)
Stylized Facts • Macro: Rapid Credit Expansion Lower Interest Rates Huge REER Appreciation • Labor Market: Significant Rise in Formalization Rates (2 definitions) Weak (Labor) Productivity Growth
Credit (as % of GDP) has increased substantially since 2004…
Since 2004 formality rates have increasedCarteira-salaried workers
Since 2004 formality rates have increasedShare with social security-all workers
And this took place amidst strong currency appreciation which shifts resources to non-tradables where informality is deemed higher…
Formality rates can be decomposed in: Yielding: Within L Between L Within S Between S Where: “L” = >11 employees “M” = between 2 and 11 employees “S” = self-employed
Can the increase in credit explain increasing formality rates?
Methodology • Examine whether sectors “structurally” more dependent of external financing formalize more when credit becomes more abundant. • Following Rajan and Zingales (1998), we measure external dependency of financing as: FDj=(K invj-cash flowsj)/K invj
Methodology • Where c=size categories: (1); (2-10); (10+)
Bottom-line of “within” regressions: • Expansion of aggregate formal credit significantly fosters formalization within each size category. • The results are robust to the alternative definitions of formalization. • Effects are much stronger for “middle-sized” and “larger” firms [consistent with the unconditional decomposition exercise of Table 1]. • Results also robust without breaking by size (log spec.): e is higher the lower F/E, so stronger for smaller caps.
Bottom-Line of Between Regressions • Greater credit availability tends to shrink the self-employment in the size distribution • Since much of the self-employment business is informal, this helps lower aggregate informality. • Conversely, the shares of upper sizes are boosted. • In particular, effect more significant among larger firms. • This may mean that credit allows firms to expand into higher size segments but we can’t test that with this dataset with no information on gross flows.
Link with Productivity [very preliminary] • Greater availability of formal credit facilitates entry and growth of smaller firms. • To the extent that these firms have a lower ratio of capital to labor, aggregate labor productivity is dragged down. • All the analysis here is from PIA which only covers industry and excludes informal firms. • And eliminates most firms with <30 employees
Conclusions • Highly imperfect credit markets seem to be a factor behind high informality rates. • The evidence suggests that improved access to credit has led to higher formalization. • Much of reduction of informality takes place via “within” effects: holding relative sector size constant, firms within each sector have an incentive to formalize their employees as credit becomes more abundant.
But also some evidence of a significant between effect – i.e. crowding out of self-owned firms by larger formal firms and faster expansion of the largest size segment during the credit boom period 2004-2007. • This is consistent with self-owned firms dying out and/or simply becoming bigger and moving to the larger size segment. • The same applies to the middle segment, which does not expand relatively much.
This is not necessarily with inconsistent with a literature on credit constraints and firm size (Bernanke et al, 1995), since our larger size category (>11) still encompasses a number of small firms. • And what is typically meant “large” in a LA context is small on a world scale (Herrera and Lora, 2003). • Alas, the PNAD does not allow a less coarse size breakdown, nor to look at gross entry/exit.
So, using alternative data sources to gauge the size composition effects of financial deepening is left for future research. • In any event, to the extent that wider credit access and formalization boost long-run productivity, our findings suggest that financial deepening can have far-reaching effects on long-term economic growth. • Our findings also highlight the importance of sound macro policies:
As you reduce macro volatility and keep inflation stable, this boosts credit supply, lower risk and hence interest spreads, thus fostering formality. • So, there is clear a link between informality, productivity and macroeconomic policy that is typically overlooked in the macro literature and policy debate. • Yet, such a positive association between credit and (labor) productivity may be tempered in the short-run.
This is because, abundant credit seems to favor the entry of smaller and lower cap firms which typically have lower labor productivity to begin with. • What happens to TFP needs to be documented. • At any rate, to the extent that credit is allocated efficiently, this (-) effect on labor productivity should be gradually overcome in the longer-run. • But this again is a matter for further research.