This paper investigates how enforcement of labor regulation affects the firm’s use of informal labor and firm performance. Using firm level data on informal employment and firm performance, and administrative data on enforcement of regulation atthe city level, we show that in areas where law enforcement is stricter firms employ asmaller amount of informal employment. Furthermore, by reducing the firm’s accessto unregulated labor, stricter enforcement is also associated with lower labor productivity.We control for different regional and firm characteristics, and we instrumentenforcement with a measure of the access of labor inspectors to firms. Taken together,our findings suggest that increased access to labor flexibility significantly improves firmperformance.
12 January 2006
Working Paper (CWP02/06)