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Published online by Cambridge University Press:  01 June 2018

Bernabe Lopez-Martin
Bank of Mexico


A quantitative framework of firm dynamics is developed where the size of the informal sector is determined by financial constraints and the burden of taxation. Improving access to credit for formal sector firms increases aggregate total factor productivity and output while reducing the size of the informal sector. Introducing size-dependent taxes reduces the gains from financial development as they incentivize firms to produce at a relatively limited scale. The aggregate effects of eliminating formal sector registration costs are positive but modest relative to previous theoretical models and the gains generated by financial development, and consistent with empirical evidence based on micro-level data.

Copyright © Cambridge University Press 2018 

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I am grateful to Tim J. Kehoe, Cristina Arellano, Fabrizio Perri, and Kei-Mu Yi for their guidance as well as to the participants of the International Trade and Development Workshop at the University of Minnesota. I benefitted from discussions with Jose Asturias, Costas Azariadis, Maria Elisa Belfiori, Javier Cano-Urbina, Pablo Cotler Avalos, Enrique Covarrubias, Alan Finkelstein Shapiro, Sandhya Garg (discussant), Ravi Kanbur, Julio Leal, Santiago Levy, David Perez-Reyna, Terry Roe, Andrea Szabó (discussant), Naoki Takayama, an anonymous referee, and participants of the Graduate Student Conference at the U. of Washington in St. Louis (2012), the 11th Midwest International Economic Development Conference (Minneapolis-St. Paul 2014), the Annual Conference in Economics and Public Policy at U. Iberoamericana (Mexico City 2015), the Macroeconomics Conference at U.A. de San Luis Potosí (2015), the Centre for the Evaluation of Development Policies Conference (EDePo IFS, London 2015), the Inter-American Development Bank and Cornell University Conference on Size and Type Based Regulations (Ithaca 2015), LACEA-LAMES (Medellin 2016) and seminar participants at Banco de México. I thank the Economic Research Forum (ERF) for access to their micro and small firm database. I gratefully acknowledge the University of Minnesota Doctoral Dissertation Fellowship for financial support. The views expressed in this article are exclusively my own and do not necessarily reflect those of Banco de México.


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