Payroll Subsidies for SMEs in Informal Labour Markets: Evidence from Colombia

We study the impact of payroll subsidies targeting SMEs on labour market formalisation in developing economies, where informal labour markets are prevalent. Our evidence is based on a payroll subsidy program in Colombia targeting firms with fewer than 50 employees, which subsidised up to 50% of the minimum wage per eligible worker. We exploit detailed administrative records, as well as discontinuities in the eligibility threshold and in the timing of program implementation, to estimate the program’s causal effect. Our findings indicate that the subsidy had a positive and persistent effect on formal employment. The impact is larger for industries receiving more subsidies but does not vary across employees’ gender. Cost-benefit analysis shows that the program was financially sustainable under a wide set of scenarios.