How Do Small Formal and Informal Firms in the Arab Republic of Egypt Compare ?

Formalizing firms can potentially increase the tax base, expand safety and social protectionsfor workers, create good jobs, and grow the economy. However, the costs and processes of formality may be toochallenging for firms, particularly the smallest firms, to bear. Thus, informal firms may not be able to survive thetransition to formality and attempts to expand formality may be harmful and counterproductive to job creation and growth.This paper investigates the potential for currently informal firms to formalize in the Arab Republic of Egypt. The papercompares the characteristics and dynamics of micro and small non-agricultural firms by formality and identifies theextent of overlap and potential for formalization. The analysis finds that, beyond firm size, the basic and easilyobservable characteristics of firms are not closely linked to formality. Firm age, productivity, and ownercharacteristics such as education are strongly predictive offormality. There is some overlap in the predicted probability of formality between formal and informal firms,suggesting some potential for formalization. The paper develops profiles (groups and clusters) of similar firms toidentify those with a higher potential for formalization. In terms of dynamics, new firms tend to be informal andinformal firms are more likely to exit (close), but conditional on firm survival, employment growth is similaracross formal and informal firms.