Finance and Employment Formalization: Evidence from Mexico's Income-Expenditure Surveys, 2000-2010: SSRN

We study the relationship between financial slack and employment formalization by exploiting heterogeneity in industry-level financial dependence in the spirit of Rajan and Zingales (1998). We use this heterogeneity along with time-series variation in aggregate credit to determine industry level financial slack and test which of two simple models of formality and finance is supported by data from Mexico. In contrast to similar studies our results suggest that more financial slack in an industry results in lower formality in that industry. This result is consistent with a theory where formal employees and/or informal firms are the capital constrained agents effected by the policy. Instead of promoting formalization our results are consistent with the notion that financial slack lets employees become informal independents and/or lets informal firms grow. Estimating the effects conditioning by age or schooling gives results that are also consistent with this notion.