both input sources and output destinations, and their use of (even basic) management practices is infrequent. Whether these common traits emerge because of optimizing choices by the informal firms or are the results of entry barriers or some other forms of exclusion is an ongoing debate in the literature on informality.<sup>5</sup> Whatever the ultimate cause, the expansion of the digital economy, and in particular the growth of e-commerce, has the potential to either shift the incentives behind these choices, for example to remain small, or to make the entry barriers less effective and, thus, ultimately to benefit informal firms. On the other hand, this expansion could exacerbate the gap between the formal and the informal sectors.

There are potentially four main channels through which the digital economy can positively impact informal firms: 1) reduce capital inputs; 2) reduce matching and verification costs; 3) facilitate implementation of management practices; and 4) facilitate market access. Digital technology, defined by Goldfarb and Tucker (2019) as “the representation of information in bits”, affects economic activity fundamentally by reducing costs (and barriers) related to search, replication, transportation, tracking and verification. A small firm entering an e-commerce platform is potentially reaching a much larger pool of customers without the need of investing in marketing campaigns, and it can also benefit from an already established set of distribution channels.<sup>6</sup> The increased use and accumulation of digital information related to online economic transactions can also facilitate the adoption of management practices such as, for example, a more frequent and accurate monitoring of costs and revenues, or improved communication with employees, suppliers and clients. Management practices have been identified as a strong determinant of productivity gains even in small firms (Bloom et al. (2013, 2020)). With more online sales, small firms can more easily and transparently document income flows and these, in turn, can provide information to banks about their creditworthiness (Klapper, Miller and Hess, 2019). In general, with more visibility, the costs of verification go down and the reputation of the firm increases.

All these channels can generate positive impacts for informal firms joining the digital economy, but it is also possible that they may work in the opposite direction. Because of the increased visibility, and the higher risk of being audited by the tax authorities, some firms may avoid entering e-commerce. This is because they would not be competitive if they had to pay taxes or comply with other regulations. E-commerce platforms can be transformative, but their market power may also polarize countries’ industrial structures. Through more intensive use of digital channels, more productive companies can expand their market shares and boost their productivity, but the platforms’ pressure to lower prices and innovate can be unsustainable for less capable firms, which may shrink or exit the market.<sup>7</sup> And even if the logistical barriers are reduced by e-commerce, some ‘transactional’ barriers may remain. Couture et al. (2021) defines these barriers as those related with “lack of familiarity with navigating online platforms” or “[lack of] trust of transactions that occur before inspecting the

> 5See de Soto (1989) and Djankov et al. (2002) for examples of those who argue for an insider-outsider dualistic view of informality, and Levy (2010) and Maloney (2004) among the proponents of the incentives-choice approach. For a recent excellent survey, see Ulyssea (2020).

> 6Note that this is different from selling to standard brick and mortar supermarkets. As the case of Chaldal shows, brick and mortar supermarkets are supplied by distributors who tend to have an established set of suppliers. A small company needs to hire someone to deliver to each of the supermarkets or enter the books of a distributor. This consists of a large supply chain investment that is often out of reach for a small company. Also, a new product can be more easily visible on a virtual shelf than it would be on a normal physical shelf.

> 7World Bank (2018) provides several examples of the negative consequences of digital platforms’ excessive market power. Iacovone et al. (2015) have a clear analogous example of the entry of Walmart, which polarized the Mexican retail market.

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