Abstract

This paper investigates how enforcement of labor regulation affects the firm’s use of informal labor and firm performance. Using firm level data on informal employ-ment and firm performance, and administrative data on enforcement of regulation at the city level, we show that in areas where law enforcement is stricter firms employ a smaller amount of informal employment. Furthermore, by reducing the firm’s access to unregulated labor, stricter enforcement is also associated with lower labor produc-tivity. We control for different regional and firm characteristics, and we instrument enforcement with a measure of the access of labor inspectors to firms. Taken together, our findings suggest that increased access to labor flexibility significantly improves firm performance.