Globally, overlap in productivity between formal and informal firms varies substantially by country context (Gelb, Mengistae, Ramachandran, & Shah, 2009; Benjamin & Mbaye, 2012).

Having a more educated owner is more conducive to formalization presumably because it makes it easier to negotiate the complex bureaucracy of formality (Almaal, 2020; World Bank, 2020). The strong association of formality with firm age also has two possible explanations: firms formalize later in the life cycle or informal firms are less likely to survive to old age. Our analysis of firm dynamics and informality, which we turn to next, suggests that the second explanation has some truth to it, but it is not clear whether the difference in survival between formal and informal firms is sufficient to account for the strong association between firm age and formality.

Our analysis of firms’ dynamics used panel data from different waves of the ELMPS to examine the relationship between formality and new firm formation, firm survival, and firm growth and formalization among firms that survive. Our findings point to the fact that informal firms experience more churn, with higher rates of firm formation and destruction among informal firms. Informal firms also seem to be more susceptible to macroeconomic conditions, exhibiting a clearer pro-cyclical pattern than formal firms.

Our data show that formalization does occur during the life cycle of firms, but that informalization also occurs, which we interpret as a possible failure to renew firm registration when it expires. In any case, registration of new businesses cannot be interpreted as new firm formation, since formalization could come fairly late in the life cycle of existing informal firms. Moreover, requiring firms to renew their registration every five years and the costs that this imposes may be a factor that contributes to higher rates of informality. Conditional on survival across waves, employment growth at the firm level does not seem to be strongly associated with the formality status in the base year, but is associated with subsequent formality, suggesting that firms that grow are also more able to afford formality.

Our results have important implications for current debates about the need to extend the scope of formality to a broader range of firms. First, it is clear that such efforts must be accompanied by attempts to streamline the process and dramatically reduce its costs, while enhancing the immediate benefits of formality, such has access to credit and input and product markets. While the costs of formality declined dramatically in Egypt from 69% to 20% of per capita income from 2007 to 2020, they may still be prohibitive for newly formed small firms (World Bank, 2006, 2020). Other aspects of formality, such as paying taxes, enforcing contracts and registering property remain prohibitively onerous and expensive. Firms presumably compare the costs and benefits of formalization when making decisions and employers who are informal in Egypt identify high costs (including time and effort) and a lack of advantages as their reasons for remaining informal (World Bank, 2014; AfDB, 2016).

Any push toward formalization should be targeted to firms that may be able to afford it, namely somewhat larger and older informal firms that hire wage workers. Efforts should, at least initially and in the current policy environment, avoid firms for whom there are few formal counterparts, such as firms operating outside fixed establishments or young/small firms. This and other work suggests that such firms, along with those with younger or female owners, no hired labor, or older low-productivity firms may be more survival self-employment than growth-oriented entrepreneurship (Krafft, 2016; Krafft & Rizk, 2018).

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