medium run until any inefficient costs associated with formality such as high registration costs, restrictive product licensing requirements and harassment/corruption costs are removed, with more productive growing informal firms likely to choose formality over time as the benefits to them become more valuable.

Policy design should therefore be informed by an assessment of the private benefits and costs of formality and informality to influence the cost-benefit calculations of firms. If unnecessary regulatory costs are a main component of firms’ cost benefit calculations, addressing these would be a priority.<sup>5</sup> If informality has generated an informality trap, support programs increasing access to resources that are critical for productivity improvements could induce firms to become more productive, grow and formalize over time. Policy design should also be informed by an assessment of the social costs of informality and the welfare benefits of formalization, i.e., those that are not captured by private business calculations. The main social benefits include a reduction of foregone tax revenues, an increase in allocative efficiency (i.e. reducing the degree to which low productivity informal firms have larger market shares than would be warranted by their level of productivity while enabling the growth in earnings and jobs of those informal firms willing and able to upgrade their productivity), an elimination of “unfair competition” facing formal firms, and strengthening the prevalence of rule based norms of behavior that would make compliance with welfare improving regulations more widespread. The relative weight of each of these sources of potential benefits will depend on country circumstances.

# **3. Formal versus informal firms and their relationship with performance variables**

# **_3.1 Formal versus informal firms_**

The Senegal data were collected through a Business Survey of microenterprises compiled by Research ICT Africa (RIA) in 2017-18.<sup>6</sup> Formal firms are defined as firms that have legally registered either at the national registrar general or country-level revenue authority, at the local authority or municipality, or both. This definition aligns with what Ulyssea (2020) refers to as the dominant approach in the literature to define informality, namely a legalistic approach: he defines informal firms as those that do not register and pay entry fees to achieve a formal status.<sup>7</sup> Informality of the enterprise is referred to as the extensive margin

> 5 As mentioned above, the recent empirical literature has emphasized that unnecessary regulatory costs, in particular unduly high registration costs do not seem to play a major role in firms’ decisions and their elimination does not seem to generate widespread formalization. In particular, Benhassine et. al. (2018) find that an effort in Benin to induce firms to formalize (while at the same time decreasing costs of formalization) resulted in a significant increase in formalization but this formalization did not bring firms higher sales or profits. De Giorgi and Rahman (2013) find that an information campaign in Bangladesh made firms more aware but had no impact on registration. More generally, in their review of the literature, Bruhn and McKenzie (2014) conclude that “evidence on the effects of entry reforms and related policy actions to promote firm formalization ... result in only a modest increase in the number of formal firms, if there is any increase at all. Most informal firms appear to not benefit on net from formalizing”. See also World Bank Group (2021).

> 6 Because RIA did not have independent information on the distribution of microenterprises, sampling for the business survey was done in parallel to the sampling for the RIA household survey examined in Atiyas and Doğanoğlu (2020). Specifically, the national census sample frames were split into urban and rural Enumerator Areas (EAs). Then EAs were sampled for each stratum using probability proportional to size. For each EA, two listings were compiled, one for households and one for firms; these listings served as the sampling frames. From each EA, 24 households and 10 firms were selected randomly. The data contain sampling weights, yielding EA-level representative data. See Mothobi et al. (2020) for a descriptive analysis of these data.

> 7 Legal requirements for any natural or legal person(s) wishing to exercise a commercial activity in Senegal include registration with the local business registry (RCCM, Registre du commerce et du crédit mobilier) and with the national tax authorities (DGID, Direction Générale des Impots et des Domaines, Senegal’s revenues and customs authority). Although the RIA data also include variables on whether the business pays local or municipal taxes and whether the business is registered for VAT or sales taxes, these are separate legal compliance issues for ongoing operation rather than entry registration: firms with annual turnover

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