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Finance and Employment Formalization: Evidence from Mexico's Income-Expenditure Surveys, 2000-2010

File Created On:
April, 2014

Source :IDB

This paper studies the relationship between financial slack and employment formalization by exploiting heterogeneity in industry-level financial dependence in the spirit of Rajan and Zingales (1998). Heterogeneity along with time-series variation in aggregate credit are used to determine industry-level financial slack and measure its relationship to employment formality. Also presented are two basic models of formality and finance as a tool to interpret the results. In contrast to similar studies, the estimates presented here suggest that more financial slack in an industry results in lower formality in that industry. This result is consistent with a model where formal employees and/or informal firms are capital-constrained agents affected by policy. The results are consistent with the notion that financial slack, instead of promoting employment formality, lets employees become informal independents and/or lets informal firms grow. Descriptive statistics on age, schooling and formality as well as estimates from samples conditioned on these variables also support this notion.

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