A Framework for Thinking About Enterprise Formalization Policies in Developing Countries

This paper emphasizes coordination and credibility issues involved in promoting firm formalization. The standard approach to firm formalization emphasizes reducing costs of compliance with government regulation. It would be more useful, however, to view compliance as a function not only of firm-level costs and benefits, but also as a function of the interaction between the firm and its competitors, and that between the firm and the state. The paper highlights the need for institutional mechanisms to communicate the benefits of formalization to firms and make the benefits of compliance and costs of non-compliance credible. Some of the most important mechanisms are those that increase benefits of cooperation, costs of non-cooperation and likelihood of detecting and sanctioning non-cooperative behavior. These include:

• Government interventions that link the compliance decision to access to markets for finance and skills;
• Private business associations that include formalizing firms and exclude non-compliant ones;
• Coordination across government agencies to improve monitoring and enforcement;
• Measures that limit the scope for predatory behavior among government officials.