Formalization, productivity, and hidden costs: Evidence from Vietnam

Abstract

This paper examines the micro-level benefits and (hidden) costs of the transition of Vietnam’s informal household businesses into the formal sector during the period 2007–2015. On the benefit side, the paper finds that such a transition, or “formalization,” leads to higher investment, greater capital stock, and a lasting increase in labor productivity, which ranges between 23 and 69 percent. There is no statistically significant increase in total factor productivity, indicating that the gain in labor productivity comes from capital deepening rather than genuine innovation. On the cost side, the paper finds evidence of a lasting visibility effect, meaning that household firms have to pay higher bribes and spend more time dealing with government red tape after formal registration. JEL codes: D21, E26, L25, 017