BPEA | Fall 2008

The Unofficial Economy and Economic Development

Fall 2008

In developing countries, informal firms account for up to about
half of all economic activity. Using data from World Bank firm-level surveys,
we find that informal firms are small and extremely unproductive compared
with even the small formal firms in the sample, and especially relative to the
larger formal firms. Formal firms are run by much better educated managers
than informal ones and use more capital, have different customers, market
their products, and use more external finance. Few formal firms have ever operated
informally. This evidence supports the dual economy (“Wal-Mart”) theory
of development, in which growth comes about from the creation of highly productive
formal firms. Informal firms keep millions of people alive but disappear
as the economy develops.