Formal firms across the size distribution face static and dynamic incentives to employ informal labor. In this paper, I explore the implications of these incentives for resource allocation within and across firms and for policies that address informality. I build and estimate a structural model in which firms employ informal labor to evade payroll taxes--a static incentive--and to avoid the adjustment costs incurred when hiring or firing formal workers--a dynamic incentive. Formal firms do not report informal labor in official data. I overcome this obstacle with a novel strategy that exploits a 2015 shock to the enforcement of Albanian tax laws to extract information about firms' use of informal labor which I use to estimate the model. I reach three conclusions. First, I show that the gains in allocative efficiency that accrue to better enforcement of labor laws are far more modest after accounting for firms' dynamic incentives to use informal labor to adjust to shocks. Second, failing to account for informal labor results in an overstatement of formal labor adjustment costs by a factor of two. Intuitively, firms use informal labor to avoid the cost of varying output, and, thus, the reported data understates variation in their actual use of labor. Third, I show that reducing the costs of rigidities in formal labor markets is as effective as enhanced enforcement in reducing the aggregate informal share of employment.
Cross country differences in corporate tax rates mean that multinational firms can use strategic profit shifting to arbitrage away tax differences. Previous studies have documented this practice and explored its fiscal consequences. I show that heterogeneous taxation has real consequences, too, distorting two choices of the global firm: where to source, and whether to open an affiliate or purchase from an arm's length supplier. To study the extent to which taxation affects these two decisions, I build a parsimonious general equilibrium, multi-country trade model with heterogeneous firms. The model predicts that a decrease in the statutory tax rate of a country induces more firms to locate to that country and to choose vertical integration over outsourcing. Using data on U.S. related-party trade I present empirical evidence supporting this prediction. Using a calibrated version of the model, I then perform a comparative statics exercise, showing that global tax harmonization would generate a global increase in outsourcing relative to vertical integration, and induce more firms to source from the U.S.
Research in progress
Foreign Demand, Wages and Informal Employment
How does an increase in foreign demand affect domestic employment, the wage distribution, and the informal share of employment in a developing economy? I use an exogenous shock to both trade and foreign firm entry in Albania in 2011 to answer this question. Disruptions due to the Arab Spring uprisings of late 2010 redirected European demand for goods previously exported from the MENA region toward Balkan countries. I construct a measure of the exposure to that shock of each manufacturing sector in Albania and examine its effects on labor market outcomes. Using microdata from the Labor Force Survey, a difference-in-difference analysis shows that the shock led to an increase in employment, overall wages, the dispersion of formal wages, and the informal share of employment.
Regional and Global Trade Strategies for Liberia (with Jaime de Melo), 2014, FERDI Working Paper P103.
Macroeconomic Effects of Fiscal Policy: a SVAR Approach, 2011, Bank of Albania Working Paper.
Nowcasting Quarterly GDP in Albania, 2010, Bank of Albania Working Paper.