Informality and productivity: do firms escape EPL through shadow employment? Evidence from a regression discontinuity design

Compliance with labour law has costs and benefits which may depend on the institutional environment in which firms operate. Although several studies have documented a negative effect of informality on firms' productivity and growth it is a fact that firms may resort to undeclared employment to escape excessive tax or regulatory burden. We argue that firms may respond to strict employment protection legislation through accrued informality thus (partially) offsetting the negative effect of informality on productivity. We exploit the Italian dismissal legislation imposing higher firing costs for firms with more than 15 workers and show that informality reduces the turnover of formal jobs for firms above the 15 workers threshold; furthermore, while the overall effect of informality on firms' productivity is negative, the differential effect for firms above the threshold as compared to smaller firms is positive and significant.