Informality among multi-product firms

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Abstract

This paper introduces product-level regulation as a new driver of informality and diversification in a model of heterogeneous multi-product firms and endogenous product choice. Firms face regulations at both the firm- and product-level and may comply with or evade either regulation. The model suggests that firm-level regulation directly causes informality by deterring firm registration. However, the product-level regulation has two effects: it directly drives product informality as evasion of product regulation leading to informality within the formal sector and indirectly deters firms from registering. Further, I demonstrate that the Gini coefficient and Herfindahl index can be implemented in multi-product firm models as revenue-based measures of product diversification. Contrary to the prediction of the commonly used product scope, the revenue-based measures indicate informal firms to be more diversified than formal firms.

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WP 2014-21 November 2014
JEL Classification Codes: L2; L5; O17
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2014-11-01
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Charles H. Dyson School of Applied Economics and Management, Cornell University
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heterogeneous firms; informality; regulations; diversification
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