Informality and Productivity: Do Firms Escape EPL through Shadow Employment? Evidence from a Regression Discontinuity Design

Compliance with labour law has costs and bene ts which may depend on the institutional environment in which rms operate. Although several studies have documented a negative e¤ect of informality on rms productivity and growth it is a fact that rms may resort to undeclared employment to escape excessive tax or regulatory burden. We argue that rms may respond to strict employment protection legislation through accrued informality thus (partially) o¤setting the negative e¤ect of informality on productivity. We exploit the Italian dismissal legislation imposing higher ring costs for rms with more than 15 workers and show that informality reduces the turnover of formal jobs for rms above the 15 workers threshold; furthermore, while the overall e¤ect of informality on rms productivity is negative, the di¤erential e¤ect for rms above the threshold as compared to smaller rms is positive and signi cant.