Competing Against the Unknown: The Impact of Enabling and Constraining Institutions on the Informal Economy

In addition to facing the known competitors in the formal economy, entrepreneurs must also be concerned with rivalry emanating from the informal economy. The informal economy is characterized by actions outside the normal scope of commerce, such as unsanctioned payments and gift-giving, as means of influencing competition. Scholars and policy makers alike have an interest in mitigating the impacts of such informal activity in that it might present an obstacle for legitimate commerce. Received theory suggests that country institutions can enable and constrain productive activity, and, in doing so, influence competitive obstacles in a country. Leveraging 13,670 responses from entrepreneurs distributed across 59 countries, we provide evidence that two particular types of enabling institutions, countries’ property rights regulations and cooperative actions, are useful for lowering the obstacles presented by informal activity. We also find evidence that two constraining institutions, economic and financial regulations lead to more obstacles presented by informal activity. We describe implications for entrepreneurs, policy makers, and future researchers stemming from these findings.