Transaction Costs in Peru:

How much does it cost to start a formal garment firm in Lima?

(work in-progress)

Miguel Jaramillo Baanante∗

Paper presented at the Annual Meeting of the Internacional Society for Neo

Institutional Economics∗∗

Tucson, September 2004

∗ Senior Researcher, Group of Analysis for Development – GRADE. ∗∗ Research sponsored by the Tinker Foundation, the Center for International Private Enterprise and the Ronald Coase Institute.

1

1. Introduction

Among traditional and less developed societies transaction costs are usually high. For this

reason, personal relations acquire great relevance for the accomplishment of commercial

exchanges. In this type of contexts, transactions take place between those who know each

other, reputation has an elevated value among agents, and the informal rules are almost

always sufficient. This allows individuals to exchange at low cost. However, in order for a

society to develop economically, it is necessary to expand markets through the

multiplication of varied and complex transactions, often requiring impersonal exchange.

The more transactions are made in an economy, the greater the market extension and,

consequently, the greater the progress in the division of labor and the possibilities of wealth

growth. Thus, public institutions should be oriented to guaranteeing low transaction costs.

Unfortunately, developing countries tend not to have the types of institutional framework

that produce low transaction costs. Because of excess of regulation and poor performance

of agencies in charge of guaranteeing the enforcement of contracts and property rights,

many productive activities are not carried out, and most of those that take place have low

levels of productivity. Given the important conceptual relationship between the level of

development of societies and transaction costs, it is critical to measure these costs and

monitor them through time. In this direction, in the last two decades, and largely inspired

by the pioneering work of Douglass North, Ronald Coase, Oliver Williamson, efforts have

been made to identify and analyze the normative burden that face economic sectors in

developing countries1. Very few of them, however, have focused on the measurement of the

transaction costs individuals who decide, at their own risk, to initiate independent

commercial activities face. These costs include those related to compliance with rules and

norms for opening a business, operating it and even closing it. The work presented here

intends to contribute to the empirics of transaction costs through the measurement of costs

faced by micro and small apparel industralists of Peru in opening their businesses and

operating them formally.

1 A recent example of a study oriented to development problems can be found in World Bank, 1998.

2

Since high formalization costs imposed by public agencies are frequently thought of as the

cause for many small firms to operate informally, costs of establishing and running

formally a small firm, and measurement thereof, must be important. Conceptually, these

costs limit their possibilities of growth by hindering the firm’s ability to engage in

contracts. Specifically, access to formal credit markets may be restricted and, consequently,

firms may be forced to underinvest. From a macro perspective, the contribution that this

enterprising sector can do for the growth of the economy, the generation of wealth and

poverty reduction is limited. In spite of these potentially negative effects there are not

adequate empirical measures of formalization costs.

This document presents the results of a pilot implementation of a methodology for

measurement of the costs of establishing a small garment firm in Lima, Peru. This

methodology has been developed through a long process by the Ronald Coase Institute and

is now being applied in several countries. It is based on information collected directly from

the entrepreneur. The results, preliminary, in correspondance with the pilot character of the

study, indicate that registration costs are high, compared to those in developed countries.

However, comparison with data for mid-eighties suggests that there has been a remarkable

simplification in procedures, and a consequent reduction in both the costs of registering a

firm and the length of the process. In addition, significant variation in the costs from firm to

firm is found.

The text is organized as follows. After this introduction, next section discusses the

characteristics of the methodology, comparing it to others previously implemented. The

third section presents the results of the exercise while the fourth concludes.

2. Methodological aspects

Costs of exchange have been systematically analyzed from the institutional perspective.

Initial empirical research focused on macroeconomic data, showing the importance of

transactions costs in an economy (Wallis and North, 1986). At the microeconomic level, the

pioneering work of De Soto (1986) attracted the attention of a broad international audience

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to the discussion of the costs of formally establishing a business in developing countries.

Following a quite simple methodology, this author elaborated estimates of the costs that a

garment industrialist in Lima had to face in order to formalize his activities. The

methodology was based on a case study, or as his author describes it, on a simulation. In

effect, the methodological strategy consisted in organizing a team to carry out the whole

process of formally establishing a small garment factory in an industrial zone of Lima.

They followed the procedures necessary to register this firm step by step, with the advise of

a lawyer specialized in Administrative Law. With all its ingenuity and illustrating power,

the methodological approach shares the limitations of any case study: costs can vary with

the characteristics of the industralist and the place where the firm is installed. Also,

entrepreneurs can develop strategies, i.e., “technology”, to reduce the costs and duration of

these processes, which a case study cannot identify. The generalization of the findings is,

thus, questionable.

More recently, the World Bank Group has initiated an effort oriented to promote private

sector development and reduce poverty through a monitoring of the "climate for business"

in a broad sample of countries. Among other objectives, the "Doing Business" project

intends to motivate reforms oriented to promote stimulating and healthy contexts for

businesses through a benchmarking of countries (World Bank, 2004)2. The most recent

publication presents results of a survey, incorporating data from 130 countries, focuses on

the requirements and procedures that an average small firm has to fulfill in order to operate

formally3. The methodology used focuses on the evaluation of norms and regulations that

concern a small business. The different procedures necessary to be formal were identified

with the help of local experts. Then, the costs and the time needed by an entrepreneur to

fulfill each procedure under normal circumstances were calculated. Normal circumstance

was defined assuming that any person on his/her own can follow the required steps, that the

involved public institutions were efficient, and that there was no possibility of corruption

that could influence the length/cost of the process.

2 Other objectives include: to promote information for the reforms design, to encourage initiatives for the effective development, and to contrast empirical evidence with the regulation theory. 3 Costs of opening a business constitute one aspect of this survey, but other essential activities within a firm are also studied: hiring workers, requesting credit, signing contracts and filing bankruptcy.

4

In order to make the data comparable across countries, a “typical” firm with the following

characteristics was selected:

- Size: 50 or more workers

- Location: the most important city of the country

- Structure of property: not less than five shareholders

- Property: 100 percent national

- Start up capital: equivalent to ten times per-capita national income.

The possiblity of making comparisons on the costs of legally operating a firm in different

countries is a strong point in favor of this methodology. However, it has the disadvantage

of using simplified assumptions that contrast with the reality of many countries. For

instance, it must ignore the existence of a positive relationship between the volume of red

tape and the magnitude of corruption, assuming that all processes are fulfilled with faithful

adherence to the letter of the law. An additional problem is that the “typical firm” chosen

may be more representative of the majority of small firms in certain countries than in

others. Unfortunately, in the Peruvian case the “typical firm” is not representative of the

universe of the micro and small enterprises. According to the last National Economic

Census (1993) almost 98 percent of businesses had less than 20 workers. In addition, the

initial capital demanded is relatively high for Peruvian standards and the concurrence of

five partners, rather uncommon.

Neither the World Bank (2004) nor De Soto (1986) considers the fact that costs can vary

with the characteristics of the individuals, as well as with other location-specific factors.

Conceptually, one would think that the education of the entrepreneur may influence the

costs of the formalization process; indeed, the more complex the procedures, the greater the

importance of the educational level of the industralist. In some contexts, it is also possible

that the legislation or the regular practice of government officials will increase the costs for

women or certain ethnic groups4. More generally, if we think about the formalization cost

4 Berham and Berham (2003) argue that prices vary not only according to the location, but also according to the characteristics of those involved in the exchange.

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of establishing a business as the opportunity cost of the resources allocated to this

objective, the time of the industralist and his/her collaborators is a key component. The

value of this time is related to individual characteristics: education, general experience,

specific experience, etc. The cost of the industrialist time will also affect its behavior in

relation to the process. Indeed, he faces different technological options: to do it himself or

delegate it to an employee of his, or maybe even hire the services of a specialist through the

market. Identifying factors related to the characteristics of the industralist and his context

that increase or reduce this specific transaction cost can allow us to better understand the

process and to produce more precise and relevant policy recommendations.

This study’s approach

This document is part of a set of studies that share the same methodological instrument,

which was developed in the Institute Ronald Coase to study and measure transaction costs5.

In general, the instrument RCI - COE measures the costs in which an agent incurs when

carrying out a certain transaction. The information is obtained through a detailed

questionnaire, which is applied directly to the person in charge of the process. This time,

transaction costs related to the formalization process faced by small firms of Lima’s apparel

industry are studied. As discussed in the previous section, although prior work offers

important contributions to the study of formalization costs, it presents important

methodological limitations. The methodology used here overcomes these limitations,

because the information is taken directly from the entrepreneur, it is not assumed that the

transaction costs are similar for each agent, and firms in our sample are closer to the typical

micro and small firm of the sector.

For this exercise information was collected from a sample of 120 micro and small

industralists of the garment sector located in the three main conglomerates of this industry

5 "Measuring the Costs of Exchange," in Institutions, Contracts and Organizations: Perspectives from New Institutional Economics, ed. Claude Ménard, Cheltenham, UK: Edward Elgar, 2000, pp. 367-375 , online at http://www.cipe.org/programs/informalsector/articles/measuring.htm and “The Costs of Exchange,” working paper, 2001, online at http://coase.org/w-benham2001thecostsofexchange.pdf.

6

in the city of Lima6. The information was collected through a questionnaire administered in

the industralists’ establishment7. Preferably information was provided by the person in

charge of the formalization process. If that person was not available, the next best option

was to interview the business owner. This was considered an adequate observation because

among small firms owners are "do-it-all" people involved in all aspects of the business.

Eighty percent of the surveys were applied to the owners or managers of the firms while in

20 percent of the cases the information was collected from other employees.

Estimation of the duration and cost of the firms’ formalization process

The first step in the estimation of the cost and duration of the formalization process was to

identify the firms that had completed the process. Out of the 120 firms in which interviews

occurred 32 operated informally8. After this, average length and cost of the formalization

process were estimated conditioning on firms having completed the process 9. This need not

be the average length/cost for all firms, since some may be discouraged to even start the

process. It may be that the cost for these firms is different, possibly because those firms are

different to start with. At this point we do not have the information to deal with this

selectivity issue. However, a new survey round is now producing data for this.

The questionnaire data give us three different posibilities to calculate the duration of the

formalization process: (1) self-report based on the firm’s own experience, (2) estimation

based on the dates of beginning and end of the process, and (3) the entrepreneur’s report of

his/her own estimation of how much would it take to open a new firm. One would expect

that results be positively correlated. In effect, the correlation between the first two

definitions is not only positive, but also high, 0.9. Correlations with the third definition are

6 In rigour we cannot guarantee that our sample is representative because the universe of garment firms created every year is not known. Figures from the Tax Administration radically differ from those of municipalities, for instance. 7 The questionnaire can be obtained from the author on request. 8 Of these, thirty declared so and the other two were detected by means of a question on the date they finished the registration process. 9 Those observations considered as outliers were dropped out of the sample. An observation was considered as an outlier if the calculated duration was greater than the value of the average duration plus three times the standard deviation.

7

also positive, though the coefficient is not so high (0.49). This is not surprising, since the

industralists when doing their prognosis consider their own previous experience as well as

possible changes in the normative context. Here we report results from the first and third

definitions.

As far as the cost of the formalization process, the instrument allows two different

estimations. The first considers the opportunity cost of the time of staff involved in the

process, payments to external help, and official fees. The second is the industrialist reported

estimate of the total cost of opening a new firm.

The requisites to be formal

The dichotomy formal / informal is not very helpful in describing firms’ relations with

official regulation in Peru. One can find different levels of formality, going from firms that

do not have any registry in the formal system whatsoever to firms that have all the registries

and comply with all their tax payments and obligations. Most firms are in the middle of

these two situations, complying with some formal obligations but not with all of them. It is

known that relatively few firms comply with all regulations while a considerable number

do not fulfill any requirement and operate without official control. The precise number is

difficult to determine, but it is known that the majority of them are small and micro firms,

oriented to local markets (Visser, 1996). A hypothesis in relation to this feature of the

Peruvian entrepreneurial structure is that informal firms avoid any and all contact with

governmental agencies, since a partial formalization implies a greater risk of detecttion.

Survey data suggests, however, that firms tend to be more formal in certain aspects that in

others. Thus, most of them have a Tax Registration Number (RUC), since without this it is

difficult to carry out transactions with other firms, whereas the formalities related to labor

aspects are the ones less complied with (Robles et al., 2001; Jaramillo, 2002).

According to Peruvian Corporate Law firms can adopt different forms to develop their

activities. Though these forms differ from each other in matters relating to the number of

people participating, the type of activity they carry out, and how easy shareholders can sell

8

their participation to third parties, they all share the limited liability character of the firm. In

addition, individuals can conduct their businesses outside the framework of Corporate Law,

without the benefit of limited liability. This category is denominated unipersonal firms.

Most micro and small firms fall in this category. They are subject to a special tax regime

and their legal exposure is different from that of incorporated firms. Assets of unipersonal

firms are not legally separated from the owner’s, which may subject to seizure to cover

firm’s obligations. Within our sample, 90 percent are unipersonal firms.

Table 1 sets out all the requirements that limited liability firms must fulfill to be considered

fully formal according to Peruvian Corporate Law10. Steps 1 through 4 are not mandatory

for unipersonal firms. This will have important bearing on the time and cost of the

formalization process.

Table 1. Steps that firms need to complete to be considered as a formal firm

1. Commercial Name (Certificate of Commercial Search and Commercial Name Reservation) 2. Trademark (Search, Registry and Publication) 3. Constitution of Firm (Notaries Fees) 4. Registration of the Firm in Public Registries 5. Registration of the Firm in the Unique Registry for Contributors (RUC) 6. Municipal Authorization and Functioning License 7. Legalization of Accounting Books and Payroll book

3. Results

On the firms included in the study

Before getting into the analysis of the registration costs themselves, it is useful to look at a

few key characteristics of the firms in the sample of the study. Most of them have one

owner, average being 1.1 owners per firm. As far as size, most interviewed firms were

microfirms, with four workers on average. This is characteristic of the business

conglomerates in which the survey was applied. As Figure 1 illustrates, 86% of the 120

10 A full description of the formal registration process is in Jaramillo (2004).

9

firms have less than five workers, the statistical mode being two workers per firm. Average

annual sales of sampled firms are around 15,000 US dollars (Figure 2).

Figure 1. Firm size

(percentages)

6.7

33.3

20.8 20.8

4.2

10.0

4.2

0

5

10

15

20

25

30

35

40

1 2 3 4 5 Between 6and 10

Between 11and 40

Source: Small and micro industrialists survey, 2003

Figure 2. Average annual sales

(US$)

14,9539,736

46,913

0

10,000

20,000

30,000

40,000

50,000

60,000

Total 1-5 workers 6 or more workers

Source: Small and micro industralists, 2003 Elaboration: Own

10

On average firms had been operating for 2,6 years before being interviewed. It must be

noted that the date when a firm began operations does not necessarily coincide with the

beginning of its activities as a formal firm. That is, it is not the general case that firms

register formally before initiating their activities. About four out of ten firms begin to

operate without having concluded their registration processes. On average, these firms

operate for about year before concluding formalization. If we consider the existence of the

firm only when its official registration process is finalized, on average the interviewed

firms are 1,9 years old.

¿Why be formal?

Operating whithin formality imposes significant costs to micro and small Peruvian

industralists. These are not only related to the registration process itself, but also include the

costs of staying formal (World Bank, 2004). If these costs are significant and the economy

is plagued with informality, “why would anyone want to operate formally?” is not a cynical

question. Is it only the perception of the detection risk that impels the industralist to be

formal? Evidence gathered in this study suggests there is more positive motivation as well.

As shown in Table 6, the two main reasons why industralists in our sample chose to

formalize their activities were: the possibility of accessing a larger number of suppliers and

customers (85%) and the possibility of obtaining credit from a formal source (70%).

Avoiding payment of fines and bribes are the following reasons. Thus, many entrepreneurs

decide to be formal not because of the benefits that it grants, but, instead, to avoid some of

the costs of being informal. Breaking down results according to size reveals no significant

differences between firms with up to five workers and those with six or more. On the

balance, firms tend to perceive advantages from enhanced access to markets associated to

formality. This result suggests that it may be possible to reduce informality through

facilitating and making the process of formalization less onerous. At the same time, this

type of policies would promote the development of small firms through expanding and

strengthening their links with markets.

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Table 2. Perceived advantages of operating formally

(percentages)

Reason Total 1-5

workers 6 +

workers

1. Access to more suppliers and costumers 85 84.5 88.2

2. Obtain credit from a formal source 70 70.9 64.7

3. Avoid the payment of fines 62.5 60.2 76.5

4. Avoid the payment of bribes 40 39.8 41.2

5. Be able to export 16.7 16.5 17.6

6 Operate on a larger scale or more visibly 15.8 17.5 5.9

7 Use the justice system to demand contract execution 13.3 14.6 5.9

8 Be able to have ads 10 9.7 11.8

9 Oobtain benefits of public programs 3.3 3.9 0 Source: Small and micro industrialists survey, 2003

Duration of the formalization process

Out of the 120 firms visited only 88 went through all the formalization process.11 As shown in

Table 3, on average industralists used 69 days to finalize the process of formalization. Results

by type of firm, firm size and male/female entrepreneurs are also reported. The process is

longer for limited liability firms, 115 days. It is also longer for firms with more than 5 workers.

This is because larger firms prefer limited liability status.

Length of process differs for men and women. On average, women industralists report

processes 18 days longer. Though the difference is not statistically significant, it raises the

question of whether there are biases against women either in the regulations or in the way

they are enforced.

11 We also did the estimates excluding eight firms where the informant was neither the onwer nor the person in charge of the formalization process. Results were not statistically different.

12

Table 3. Reported and predicted duration of formalization process

Reported Predicted

n Duration n Duration

Mean 85 68.9 84 43.8

By type of firm Unipersonal 75 62.7 75 43.7

Limited liability 10 115.3 9 44.8

By firm's size 1-5 workers 70 62.3 69 42.7

6 or more workers 15 99.8 15 49

Sex Male 52 61.8 51 41.8

Female 33 80.0 33 46.9

1/ For this estimation observations considered outliers--those reporting a duration of less than 5 days or greater than one year--were dropped. Source: Small and micro industralists, 2003

The industralists also reported the time they think it would take them to formalize a new

business now (columns 3 and 4). On average, they considered it would take 44 days to

finish the process. Interestingly, there are no differences on this for limited liability and

unipersonal firms. Expected length is also similar for men and women. In addition,

contrasting with the reported duration of the formalization process already experienced, the

difference in predicted duration between men and women is only five days. It is interesting

that industralists tend to consider that the formalization of a new firm would take less time

than the one that indeed took them in their own experience. However, we cannot say

whether this is the result of perceived changes in the institutional environment or that they

think prior experience will help them.

Money costs of the formalization process

Small business owners not only dedicate part of their time to formalize their activities,

supervising the process or running related errands themselves. In addition, they must

assume costs related to the payment of official fees, assignment of personnel for the

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completion of procedures involved and other related expenses. In some instances (two in

our sample), they may even find it necessary to make unofficial payments in order to

accelerate the process. The technology to carry out the process can vary from firm to firm.

A considerable portion of firms (43 percent) hired the services of a person or agency with

the intention to advance at least part of the process. As expected, this is more frequent (69

percent) within firms with more than five employees, since size allows for greater

specialization of the entrepreneur in tasks of greater value for the firm.

One aspect worth emphasizing is the significant variability in the costs of the formalization

process. The dispersion of this cost shows in the density function (Figure 3). The evidence

that formal registration costs varies from firm to firm validates the methodology used here,

by suggesting that this cost can be influenced by characteristics of the firm, the

entrepreneur, or the strategy used deal with the process.

Figure 3. Empirical density function of the cost of the formalization process

______ normal density

densidad

1.39583 7.78405

0

.617449

Formalization cost of the firms (in logarithms)

Table 4 sets out estimated costs based on industrialists’ report and the cost of formalizing a

new firm as predicted by the industrialist. Average cost of the formalization process

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conditional on having finished it is US$ 117. Industralists owning a unipersonal firm

incurred a cost (US$ 105) about half that of a limited liability firm (USS 233). Similar to

the duration of the process, among firms with less than 5 workers the cost of formalization

is smaller, because most of them are unipersonal enterprises. Also, the formalization

process costs women about 9 percent more than men. The difference, however, is not

statistically significant. Finally, it should be noted that the main component of the cost is

oficial fees, accounting for two-thirds (unipersonal) to three-fourths (limited liability) of

total reported costs.

Tabla 4. Reported and predicted formalization costs

Cost Incurred Predicted Cost

n US $ n US$

Mean 85 117 85 156.5

By type of firm Unipersonal 77 105 76 138.2

Limited liability 8 232.3 9 310.8

By firm's size

1-5 workers 72 108.3 72 145.0

6 or more workers 13 165 13 219.6

Sex

Male 52 113.1 53 148.4

Female 33 123.2 32 169.8

Source: Small and micro industrialists survey, 2003

As far as the entrepreneur’s predictions of how much it would cost to formally register a

new business, they point out to higher costs. Indeed, according to those interviewed, the

formalization of a new business would cost about 171 dollars. Those who own unipersonal

firms consider that this process would cost USS 155, while for those that established them

as limited liability it would cost approximately USS 311. The difference of costs between

men and women comes up again, and in this case the test of means indicates that the

difference is significant.

15

What factors determine the duration and cost of the formalization process?

Since our results suggest that the cost of the firms’ formalization process could be

determined by characteristics of the industralists and their firms, or the technology they use

for the process, a regression analisys was conducted to explore determinants. The

considered explanatory variables and descriptive statistics are in the Appendix.

Table 5. Regressions of the cost of the

formalization process

Formalization

cost

Predicted cost of formalizing

new firm

Sex -0.02 -0.17 (0.08) (1.28) Age 0.02 0.01 (1.44) (1.25) Education 0.03 -0.05 (0.27) (0.79) Previous experience 0.43 -0.07 (1.89) * (0.5) Type of firm -0.73 -0.42 (2.00) ** (1.92) * Capital investment 0.03 0.10 (0.3) (1.65) Size 0.01 0.01 (0.45) (0.98) Outside help 0.53 -0.03 (2.29) ** (0.23) Constant 4.83 5.62 (3.95) *** (7.96) *** Observations 83 82 R-squared 0.19 0.21 F 2.12 2.49 variables 8 8 Degrees of freedom 74 73 Absolute value of t-statistic in parenthesis. * significant at 10%; ** significant at 5%; *** significant at 1%

Source: Small and micro industrialists survey, 2003

As shown in Table 5, variables significantly associated with the cost of formalization are:

the type of firm (unipersonal/limited liability), the hiring of help from outside the firm for

at least part of the process, and previous experience. As said above, the process of

registration of a limited liability firm involves additional steps that make the process more

16

expensive, so this result is not surprising. Also, hiring someone from outside the firm tends

to increase the cost. This is probably compensated by the value of the industralist’s time or

that of the personnel that is relieved from involvement, since they can focus on other

activities of the business. The fact that, as noted before, the largest firms have a greater

propensity to hire outside help, suggests that there are associated efficiency gains of doing

this. Thirdly, the sign of the previous experience variable is puzzling. However, it may be

that procedures have changed so much that there is a cost of “unlearning”. On the predicted

cost of registering a new firm, only the type of firm turns out significant. Finally, it must be

noted that although the sign of the variable sex is negative, suggesting an additional cost for

the women, in no case this coefficient turns out statistically significant12. Overall, results

suggest that costs are more associated to the technology used in dealing with the process

than with the individual characteristics of the entrepreneur.

Our results compared to previous studies

In comparing our results to those of previous studies, we find important differences. Table

6 compares the numbers. The duration of the formalization process estimated by the World

Bank (2004) is 45 percent greater than the average duration reported by micro and small

industralists in our survey. In the same line, their cost is more than four times that estimated

here. However, the most relevant comparison is the one with our estimates for limited

liability firms, which are the type of firms on which that study focuses. Even considering

this, big differences on formalization costs are found, although the difference in the

duration of the process is rather small.

Tabla 6. Comparison of our results with other studies

Jaramillo (2004)

World Bank (2004)

De Soto (1986)

All firms Limited liability

Process lerngth (days) 100 420 68.9 115.3 Cost (US dolars) 510 1200 117.0 232.3

12 If the regression is estimated without dropping outliers, this variable turns out to be significant in explaining the predicted cost, but not in explaining the actual cost.

17

Also, when comparing with De Soto’s results, we find considerable differences. De Soto’s

estimated process length is six times greater than ours, whereas the cost is ten times greater.

This could be due in part to the methodological differences discussed in a previous section.

However, much of this difference may be explained by a remarkable reduction in the

duration and cost of the process as a consequence of a normative reform at the end of the

eighties and early nineties that simplified the process substantially.

Although, on one hand, there have been significant improvements in relation to previous

periods and, on the other hand, costs are probably not as high as the World Bank (2004)

suggests, yet all the same there are important differences with developed countries in

process length as well as in its cost. Among countries such as Canada, United States or

New Zealand the process takes less than 5 days (World Bank, 2004). In these same

countries the formalization cost for a limited liability firm represents about 1 percent of per

capita national income, whereas in Peru it represents over 10 percent. However, results also

suggest that registration costs can hardly represent a serious impediment to the

formalization of firms. From this perspective, it is not the cost of formalizing, but that of

staying formal that would be behind the high rates of informality in the Peruvian economy.

4. Final remarks Average costs and duration of the formalization process turn out smaller than those found

in previous studies. First, estimates presented here differ from those of the World Bank

(2004) due to methodological differences. Specifically, the "typical firm" of their study is

very different from the firms considered in our sample. In fact, the "typical firm" does not

share the characteristics of the large majority of firms that are created in Peru. Second,

differences with estimates by De Soto (1986) may be explained by both methodological

differences as well as normative changes implemented in the last fifteen years, which were

partly prompted by that study. We conclude that although still high when compared to

those in developed countries, formal registration costs could hardly be blamed for the high

rates of informality in Peru.

18

Our results, preliminary as they are, suggest a mild optimism on the possibilities of

reducing informality rates. Firms perceive advantages in greater access to markets,

associated to formality. This result suggests that there is a demand for formality, and,

therefore, it is possible to reduce informality through facilitating the registration and

licensing processes. At the same time, this kind of policies can promote the development of

small firms through expanded market access. In addition, the largest part of the

formalization cost is explained by official fees. An effort to reduce these fees may provide

incentives for firms to register formally. However, exclusive focus on this front, without

consideration of the costs of staying formal, would probably produce disappointing results.

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References

Benham, Alexandra and Lee Benham. 2000. “Measuring the Costs of Exchange” in Claude Ménard, Mary Shirley (eds.), Institutions, Contracts and Organizations: Perspectives from New Institutional Economics.. UK: Edward Elgar, pp. 367-375. Benham, Alexandra and Lee Benham. 2001. "The Costs of Exchange" The Ronald Coase Institute and Washington University in St. Louis. Burki, Shahid Javed and G. Perry. 1998. Más allá del consenso de Washington: La hora de la reforma institucional. Washington, D.C.: Banco Mundial. De Soto. 1986. El Otro Sendero: La Revolución Informal. Bogotá: ILD. 8ª edición. Douglas. North. 1990. Institutions, Institutional Change and Economic Performance. New York: Cambridge University Press, 1990. Harris, John R. and Michael Todaro. 1970. “Migration, Unemployment and Development: A Two Sector Analysis”, en American Economic Review, marzo, pp.126-42. Lewis, Arthur. 1954. "Economic Development with Unlimited Supplies of Labor", Manchester School of Economic and Social Studies, 20, pp. 105-138. Rauch, James E. 1991. “Modeling the informal sector formally”, in Journal of Development Economics, 35, pp.33-47. Robles, Miguel et al. 2001. Estrategias y racionalidad de la pequeña empresa. Lima: Oficina Internacional del Trabajo y GRADE. Villarán, Fernando. 1998. Riqueza Popular: Pasión y Gloria de la Pequeña Empresa. Lima: Congreso de la República. Visser, Evert-Jan et al. 1995. Gamarra al garete: concentración local y aislamiento global. Lima: DESCO. Wallis, John J., and Douglass C. North. 1986. "Measuring the Transaction Sector in the American Economy, " in S.L. Engerman y R.E. Gallman, (eds.), Long Term Factors in American Economic Growth, Chicago: University of Chicago Press. World Bank. 2004. Doing Business in 2004: Understanding Regulation, Washington, D.C.: The World Bank and Oxford University Press. Yamada, G. 1996. “Urban Informal Employment and Self-Employment in Developing

Countries: Theory and Evidence”, Economic Development and Cultural Change, vol. 44, n. 2.

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Appendix

Table A1. Variables incorporated in the regression

Variable Description

Sex Dummy: 1 when the interviewed person was a man, 0 in other cases Age In years

Expresses the educational level of the interviewed person 1 Incomplete primary school 2 Complete primary school 1 Incomplete high school 2 Complete high school 5 Incomplete superior

Education

6 Complete superior

Dummy: 1 when the person in charge of the process had a previous Previous experience

experience in the registration of a firm Type of firm Dummy: 1 if the firm is unipersonal, 0 in other cases Capital investment Logarihtm of the value of capital investment (in nuevos soles) Size Number of employees of the firm

Dummy: 1 if the firm hired an agent outside the firm Outside help

Table A2. Descriptive statistics of the variables incorporated in the regression

Variable Obs. Mean Est. Desv. Min Max

Logarithm of the formalization cost of the firm 85 5.68 0.98 1.61 7.57Logarithm of the formalzation of a new firm 85 6.12 0.58 4.61 7.60Duration of the formalization process of the firm 85 68.89 92.71 5 450Duration of the formalization process of a new firm 84 43.82 31.07 5 210Sex 88 0.61 0.49 0 1Age 88 37.73 10.08 18 59Educative level 88 4.72 1.08 1 6Previous experience 88 0.60 0.49 0 1Type of firm 88 0.89 0.32 0 1Logarithm of the capital investment 85 9.29 1.18 5.99 12.77Size of the firm 88 4.56 6.06 1 40Outside help 88 0.43 0.50 0 1

Source: Small and micro industrialists survey, 2003