similarly productive to formal firms (Gelb, Mengistae, Ramachandran, & Shah, 2009; Benjamin & Mbaye, 2012). In some contexts, informal firms were more like formal firms, suggesting potential for formalization.

The reasons firms in Egypt are informal are tied up with costs, although it is not clear if the costs would preclude firm survival and growth. Employers who are informal in Egypt state that their most common reason for remaining informal is that it “saves time and effort” followed closely by “formalization does not involve advantages” (25%-30%). Financial reasons – “no need to pay employees’ social insurance” and “no need to pay taxes” are the next most common reasons (around 15%), followed by no need to apply labor laws (around 6%-7%) (AfDB, 2016). Since firms are presumably engaged in a cost-benefit analysis when making their decisions to remain informal, that calculus will likely have to change to induce them to formalize (World Bank, 2014).

There have been substantial recent improvements in the procedures to start a new business (or to formalize an existing business) in Egypt. Although the cost of formally starting a business declined from 69% of income per capita in 2007 to 20% in 2020, it may still be prohibitive for very small firms (World Bank, 2006, 2020). Similarly, the time required to start a business fell from 19 days in 2007 to 12 days in 2020. Egypt’s rank in starting a business has accordingly improved from 165<sup>th</sup> out of 175 economies in 2007 to 90<sup>th</sup> out of 190 economies in 2020 (World Bank, 2006, 2020). However, other aspects of formality, such as paying taxes, enforcing contracts, and registering property remain extremely burdensome, with Egypt ranking 156<sup>th</sup> out of 190 economies in paying taxes, 166<sup>th</sup> in enforcing contracts, and 130<sup>th</sup> in registering property in 2020 (World Bank, 2020).

The assumption underlying the calls to formalize informal firms is that small informal firms, or at least subsets of them, can be formalized. This implies that informal and formal firms are similar to each other in terms of productivity, employment, types of activities, location, etc. This assumption implies that formalization would be feasible and requiring formality would not result in the firm instead disappearing altogether. This paper sets out to test whether currently informal firms in Egypt are “formalizable” and, if so, which firms, in particular, might be susceptible to formalization.

We use multiple data sources from Egypt to assess which firms are more likely to be formal. We then quantify the amount of overlap between formal and informal firms in terms of their predicted probability of formality, based on observable characteristics. While we find some overlap in the probability to be formal, particularly among firms in fixed establishments, we also find that many informal firms have a low probability of formality and may not be formalizable. We create profiles (clusters, groups) of firms with similar characteristics to explore which informal firms are more, or less, likely to formalize. We also explore the relationship between firm dynamics and formality. We conclude that, in the current landscape in Egypt, while enforcement and encouragement may yield some progress in expanding the formal sector, more substantive reforms to the process and practice of formality are likely needed to substantially expand the formal sector.

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