of section 4 by the analogous coefficient from the informality regressions. Taking our preferred speci fi cation, the parameters of interest are -3.48 for informal employment, -0.125 for log value added per employee and -0.045 for log wage (see table 2). Therefore, an increase in the proportion of informal employment by 1 percentage point leads to an increase in productivity of 3.59% (and since the proportion of illegal workers in the average fi rm in the sample is 23% this corresponds to an elasticity of productivity with respect to informal employment of 0.83) and an increase in wages of 1.29% (corresponding to an elasticity of 0.3). Taking the highest estimate for the effect of registration fi nes on informal labor from the instrumental variable speci fi cations in table 4 (which is -6.28) and the lowest estimate of the effect of registration fi nes on value added, from table 6 (which is -0.1), an increase in the proportion of informal employment by 1 percentage point leads to a decrease in productivity of 1.59% (corresponding to an elasticity of 0.37). The corresponding estimate for wages is -0.045<sup>44</sup> , which means that an increase in the proportion of informal employment by 1 percentage points leads to an increase in wages of 0.7% (an elasticity of 0.16). All of these are large in magnitude suggesting that labor fl exibility has very strong effects on fi rm performance.

An alternative way to compute these parameters is to estimate a regression of measures of performance on the fi rm’s informal employment instrumenting informality with enforcement.<sup>45</sup> In table 8 we present OLS and IV regressions of the effect of the proportion of informal workers hired by the fi rm on the different measures of fi rm performance (log value

> 44The corresponding table for the IV estimates for the log average wage are not reported but are available on request.

> 45Even if fi rm level informality is measured with error, we are instrumenting the variable which should be enough to eliminate bias in the coefficient of interest, as long as measurement error is classical. However, measurement error may be not classical in our case. On one end, informal employment is bounded below by zero which may introduce a negative correlation between the true value of the variable and measurement error. On the other end, it is possible to think of several different ways in which respondents decided to answer the informality question and which would lead to non-classical measurement error. For example, in the case where fully legal fi rms always told the truth and some of the fi rms employing illegal workers underreported their informal employment there would be a negative correlation between measurement error and the true value of the variable. It may also happen that, since the exact phrasing of the question requires an answer about other fi rms and not about ones fi rm, fully legal fi rms report a positive value for the informality variable because some of its major competitors do employ informal workers, again generating a negative correlation between the report and the true value of the variable. Finally, we have already mentioned that measurement error may be negatively correlated with the instrument if fi rms underreport more in areas where enforcement is stricter. Unfortunately, it is not possible to predict which of these arguments is more important and what is the resulting sign of the bias.

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