Credit Labor Informality And Firm Performance In Colombia

IDB WORKING PAPER SERIES No. IDB-WP-325

Credit, Labor Informality and Firm Performance in Colombia
Lorena Caro Arturo J. Galindo Marcela Meléndez

June 2012

Inter-American Development Bank
Department of Research and Chief

Credit, Labor Informality and Firm Performance in Colombia

Lorena Caro* Arturo J. Galindo** Marcela Meléndez*

* ECON ESTUDIO ** Inter-American DevelopmentBank

Inter-American Development Bank 2012

Cataloging-in-Publication data provided by the Inter-American Development Bank Felipe Herrera Library Caro Zambrano, Lorena del Pilar. Credit, labor informality and firm performance in Colombia / Lorena Caro, Arturo J. Galindo, Marcela Meléndez. p. cm. (IDB working paper series ; 325) Includes bibliographical references. 1. Microfinance—Colombia. 2.Informal sector (Economics)—Colombia. 3. Labor market—Colombia. I. Galindo, Arturo J. II. Meléndez Arjona, Marcela. III. Inter-American Development Bank. Research Dept. IV. Title. V. Series.

http://www.iadb.org Documents published in the IDB working paper series are of the highest academic and editorial quality. All have been peer reviewed by recognized experts in their field and professionallyedited. The information and opinions presented in these publications are entirely those of the author(s), and no endorsement by the Inter-American Development Bank, its Board of Executive Directors, or the countries they represent is expressed or implied. This paper may be freely reproduced.

Abstract1 This paper explores the links between labor formality, access to credit and firm performancein Colombia using Annual Manufacturing Survey data for the period 2000-2009. A significant though small relationship is found between access to credit and informality. The results suggest that a 10 percent increase in the ratio of credit to sectoral output increases labor formality between 0.76 and 1.14 percentage points. This effect vanishes as a firm’s financial constraint increases. The paperalso reports a strong correlation between labor formality and firm performance measured as output and employment growth. A one percentage point increase in labor formality is associated with an 8.5 percent increase in output and an 11 percent increase in employment growth. JEL classifications: E26, G21, O4, O16 Key Words: Credit markets, Financial constraints, Informality, Colombia

We aregrateful to Paula Mejía who helped us in the revisions for this version of the paper. We are also grateful to DANE, the National Statistics Agency of Colombia, for access to the Annual Manufacturing Survey microeconomic data, without which this research would not have been possible. This dataset was accessed at DANE’s facilities under monitored conditions to ensure compliance with statistical reserveregulations. The views in this paper are exclusively those of the authors and do not represent those of the IDB or its Board of Directors.

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1. Introduction
There is considerable consensus in the finance and development literature that financial development fosters economic growth (Levine, 1997; Beck, Levine, and Loayza, 2000). This argument is based on the idea that well-functioningfinancial markets allow firms to undertake investments and through them realize productivity gains that would not be possible when there is high dependence on external finance (Rajan and Zingales, 1998). There is also significant consensus that informality of firms and of employment arrangements, understood as the lack of compliance with taxes and regulations, restricts growth, because informalityis associated with allocative inefficiencies that lead to under-investment and to lower total factor productivity (Farrell, 2006; Perry et al., 2007; Levy, 2008; La Porta and Shleifer, 2008; D’Erasmo and Moscoso Boedo, 2009; Hsieh and Klenow, 2009). Moreover, because informality shrinks the national tax base, it often induces higher compensatory taxes to be levied on formal businesses that, in...