Informality, Size, and Regulation: Theory and an Application to Egypt

The paper shows how, when the enforceability of regulations is size-sensitive, price competition can lock firms into informality and, thus, smallness, depending on the form of the production function. In that context, exogenous "help" packages targeted to informal firms "promote" micro and small enterprises (i.e., increase their numbers) but do not "develop" them (i.e., foster their growth). The "help" only generates a short-term span of abnormal profits for existing informal firms, and a long-term income transfer toward informal-market consumers. The model is tested in the context of Egypt's micro and small enterprise sector.