Public financing and financial frictions and underground economy

What are the aggregate effects of informality in a financially constrained economy? We
develop and calibrate an entrepreneurship model to data on matched employer-employee
from both formal and informal sectors in Brazil. The model distinguishes between informality on the business side and the hiring of informal workers by formal businesses. Policies that reduce business informality increase aggregate output by 10.8%, TFP by 6.6%, and tax revenue by 33.2%. On the contrary, output and TFP decrease when policies reduce the
intensive margin of informality, underscoring that the informal economy can play a positive role in an economy with financial frictions.

Public financing and financial frictions and underground economy Articles