The Peruvian Informal Economy: Causes and Consequences

Abstract

The informal economy is of concern due to its negative socio-economic and fiscal consequences which is why its measurement has become a crucial aim in the literature. However, estimating the size of the informal economy is a challenging endeavour as there is no established definition or method for it. Apart from that, great effort has been implemented into establishing what are the factors causing or contributing to its persistence to be able to craft policy responses aimed at formalizing the economy.
The present dissertation analyses the causes and consequences of the informal economy in Peru with the use of a mixed methods approach. First, it quantitatively attempts to estimate the Peruvian informal economy (% of GDP) using the Currency Demand Approach (CDA) and the Multiple Causes Multiple Indicators (MIMIC) model. Second, it uses probit and logit models to find the individual characteristics related to becoming formal or informal, being informal, secondary informal employment and the firm characteristics that makes a firm willing to formalize. Third, it qualitatively conducts interviews to Peruvian micro- and small-sized enterprises to support the quantitative findings.
The results demonstrate that although the measurement methods showed contradicting findings, this further supports the concern in the literature of the estimation of the informal economy. At an individual level, it finds that informal Peruvians are mostly female, younger, part of a minority group, separated or divorced and less educated working in the agriculture, transport and communications sectors. In terms of informal firms, this dissertation finds that their intention to formalize is affected by their size, sector, location, owner’s gender, and the education of the owner’s parents but when controlling for their perceptions about formality, the results suggest that their intention increases with better infrastructure and finance and less bureaucracy in the formal sector.