Credit constraints, informal sector and productivity

Abstract

Based on a standard model of entrepreneurship and credit, as proposed by Evans and Jovanovic (1989), this study aims to examine the effects of taxes and credit constraints on agent's occupational choices. With this purpose, the possibility of coexistence of entrepreneurs working in the formal and informal sectors will be added to the basic model. The main difference between both sectors lies in the fact that the formal one pays taxes and can borrow through a collateral, given by a proportion of the individual wealth. On the other hand, at the informal sector there is no incidence of taxes, but all funding should be given via firms own resources. Additionally, tax rates on salaries and incomes of formal enterprises will be included. Each individual has an endowment of wealth and entrepreneurial skills. Therefore, we propose a model that analyzes the static decision between work or become entrepreneurs, formal or informal, against distortions in the credit market and taxes. From the occupational choices of agents, we intend to analyze how these influence the income distribution, composition across sectors and aggregate productivity. (AU)