MSMEs and the Cost of Using Capital

Micro-business populate most of the demography of firms in developing countries. However very often this firms are discouraged to hire skilled workers and to accumulate capital, and therefore to be productive. The lack of incentives to accumulate capital occurs not only because interest rates are decreasing in capital, but also because they are subject to tax deductions that cannot be used by firms too small to be subject to taxes. This paper estimates a general equilibrium model that includes an endogenous extensive and intensive margin of informality, a tax structure that considers waivers to small firms and deductions to larger firms, capital and a cost of using it that follows a logistic function behavior, resembling what is found in the data. The model is calibrated for the case of the manufacturing sector in Colombia. Simulations suggest that policies oriented to increase the use of capital in one group, without any more policies to reduce the average cost of using capital, imply an increase of the cost of using capital for other groups. Therefore, policies to reduce the informal distortion of using capital can increase formal firm’s productivity but reducing the size of the formal sector, thus harming overall productivity. On the other hand, policies oriented to reduce the size distortion of using capital can increase formality maintaining output and productivity relatively stable, because both tales of the productivity distribution are equally affected.