Navigating Growth: A Formalized Approach to Small Firm Revenue and Profit Enhancement

Abstract Governments often have strong motivation to formalize ever-growing informal firms. However, whether formalization improves the earnings of small firms is a crucial policy question. Firms chose to be formal so the impact evaluation of formalization suffers for self-selection bias. This study aims at examining the impact of the impact of formalization on revenue and profit of informal small firms using Randomized Encouragement Design. Small firms in Malawi, one of the poorest countries, are considered as the units of analysis in the present study. This study uses dataset prepared by Campos et al. (2018) who conducted Randomized Control Trial to examine different ways to formalize small firms in Malawi. Campos et al. (2023) examined the impact of Offer for cost-free business registration, coupled with a bank account opening information session as one of the treatment variables and formalization as one of the outcome variables in their study. In contrast, this study considers the offer for cost-free business registration, coupled with a bank account opening information session as an instrumental variable and formalization as the treatment variable. The result shows that formalization significantly increases revenue and profit of small firms. Heterogeneous impact analysis suggests formalization helps only manufacturing farms to earn more.