On the Short- and Medium-Term Effects of Formalisation: Panel Evidence from Vietnam

Abstract

This paper analyses the consequences of formalisation on the performance of informal firms, using a panel dataset from Vietnam. We find that switching firms (before switching) have higher profit and value added compared to non-switching firms; suggesting heterogeneity. Becoming formal leads to an additional increase in switching firms' profit and value added. The benefits of formalisation materialise in the short-term (one year) and persist in the longer-term (three or more years). These benefits run through various channels such as better access to powered equipment or higher business association membership; but not better access to credit.

Why do household businesses in Vietnam stay informal?

“…To examine the impacts of formalization on household performance and tax payment, we follow the method proposed by Boly (2017). The benefits of formalization on household performance and tax payment can be estimated using the following equation:…”

“…The literature which studies the benefits of formalization can be split into two types: experimental and non-experimental approaches. Experimental studies involve the use of randomized control trials and often show that the costs of formalization outweigh the benefits (Boly, 2017;McCaig and Nanowski, 2017). On the other hand, almost all non-experimental studies which use either cross-sectional analysis (Fajnzylber et al, 2009(Fajnzylber et al, , 2011McKenzie and Sakho, 2010;Monteiro and Assunção, 2012,) or panel data (Boly, 2017;Demenet et al, 2016;Rand and Torm, 2012a) reveal the benefits of formalization.…”

“…Experimental studies involve the use of randomized control trials and often show that the costs of formalization outweigh the benefits (Boly, 2017;McCaig and Nanowski, 2017). On the other hand, almost all non-experimental studies which use either cross-sectional analysis (Fajnzylber et al, 2009(Fajnzylber et al, , 2011McKenzie and Sakho, 2010;Monteiro and Assunção, 2012,) or panel data (Boly, 2017;Demenet et al, 2016;Rand and Torm, 2012a) reveal the benefits of formalization. For instance, Rand and Torm (2012a) report an increase in profits of 12 to 16 per cent, Demenet et al (2016) show a growth of 20 per cent in value added while Boly (2017) report an increase in profit and value added of 9 to 11 per cent due to formalization in Viet Nam.…”

“…In spite of the benefits of formalization such as the improvement in firms' profits and customer base, better access to infrastructure and other public goods, and protection from corruption (Boly, 2017;Cling et al, 2012;Demenet et al, 2016;Fajnzylber et al, 2011;McKenzie and Sakho, 2010;Rand and Torm, 2012a), the informal sector remains large (La Porta and Shleifer, 2014;Williams et al, 2016). This sector is observed with a heterogenous structure which is composed of 'lower' tiers of vulnerable workers with low levels of education and 'upper' tiers of high earnings and skilled employers.…”

“…It should be noted that in this research the division of household businesses into 'lower' and 'upper' tiers is based on households' revenues. This classification is closely related to the entrepreneurs' ability, as empirical evidence shows that businesses with higher value added and profits are run by more educated owners and have more workers (Rand and Torm, 2012a;Nguyen et al, 2013;Boly, 2017).…”