## 1. Trade Pattern

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---

### Trade pattern and recent dynamics
- Paraguay exhibits a downward trend in both exports of goods and services and trade openness as a percentage of GDP over recent periods, while other landlocked comparator countries showed a sustained increase.
- Despite the decline, Paraguay’s levels of exports and trade openness remain above the 25th percentile of the global distribution and above those recorded for most LAC peers.
- Goods export market concentration:
  - Declined from the 2006-2009 average to 2010-2019 (diversification of export destinations).
  - Resurged in 2020 and declined in 2021 and 2022, reflecting a recent shift toward fewer export destinations amid reduced exports due to drought.
  - Overall goods export concentration remains below that of other landlocked countries with similar economic attributes and below the broader group of LAC countries.
- Product concentration:
  - Declined between the initial period and the subsequent decade, signaling diversification in exported products.
  - Paraguay’s product concentration is lower than similar landlocked countries and, since 2021, lower than that observed across the group of LAC countries.

### Objectives, scope, and data
- Aim: Assess whether Paraguay’s trade volumes are lower or higher than expected given its economic and geographical characteristics and identify non-gravity factors that may hinder integration.
- Explicitly evaluates:
  - Trade policies (tariffs and non-tariff barriers).
  - Transport infrastructure, customs efficiency, and logistics.
  - Production factor quality and access (including human capital).
  - Governance quality and business entry costs.
- Comparator groups: other LAC countries, South America, and landlocked countries similar to Paraguay (e.g., Armenia, Belarus, Botswana, Mongolia, North Macedonia, Serbia).
- Data sources and measures:
  - Goods trade flows: BACI: International Trade Database at the Product-Level (Zignago and Gaulier, 2010), reconciled at country-pair aggregate export value level for 2000 to 2021 using mirrored data from UN Comtrade.
  - Gravity variables: Conte, Cotterlaz, and Mayer (2022) gravity database.
  - Trade policy: importer’s trade MFN tariff from WITS.
  - Infrastructure/logistics/customs: World Bank Logistics Performance Index (LPI).
  - Digital infrastructure: mobile broadband subscribers per 100 people.
  - Macroeconomic indicators: IMF World Economic Outlook (GDP, population).
  - Human capital: Human Capital Index from Penn World Tables (PWT).
  - Governance: World Governance Indicators (control of corruption, rule of law, absence of violence).

### Econometric strategy
- Estimation method: Enhanced gravity model using Poisson pseudo-maximum likelihood (PPML) to handle zero trade flows (Santos Silva and Tenreyro, 2006).
- Specification and controls include average GDP, population (POP), bilateral distance (d), dummies for common language and shared land border, landlocked status, trade policy factors (TP), logistics/customs/production factors/governance vectors (Z_i, Z_j), and a PRY dummy for Paraguay partner.
- Benchmarking includes dummies for LAC, South America, and landlocked countries similar to Paraguay.
- Estimation approach: step-by-step inclusion of variable groups following Bhattacharya and Pienknagura (2024), beginning with a basic gravity model and progressively adding policy and structural variables.
- Note: The study does not estimate a fully saturated gravity model (no country-pair fixed effects); results are not framed in a structural gravity framework.

### Key empirical findings on Paraguay’s trade
- Benchmark result:
  - After accounting for key macroeconomic characteristics in the gravity model, Paraguay’s trade is estimated to be about 10 percent higher than comparable trade flows outside of Paraguay.
- Over-trading pattern:
  - Paraguay exhibits trade integration above expectations (“over-trading”) given its economic and geographic characteristics.
  - LA-7 countries also show over-trading, driven primarily by Mexico’s relationship with the US market.
  - Other landlocked countries with economic profiles akin to Paraguay also show over-trading, but less pronounced.
- Role of policy and structural variables:
  - The Paraguay over-trading result is not attributable to superior infrastructure, production factor quality, or governance; the over-trading coefficient remains largely unchanged across model specifications and increases when policy variables are added.
  - Implication: Paraguay’s elevated trade flows occur despite the country’s specific attributes, not because of them.
- Regional drivers of under-trading:
  - For LAC as a whole, deficiencies in infrastructure significantly contribute to under-trading.
  - Low governance quality is a major barrier to trade within LAC and South America.
  - Accounting for infrastructure substantially mitigates and effectively resolves the under-trading problem in South America.
  - For landlocked countries similar to Paraguay, production factors matter: when accounting for HCI and costs of initiating a business, over-trading vanishes and turns negative, implying expected trade volumes would be higher given average human capital.

### Policy implications and recommendations (trade)
- Cross-cutting priorities:
  - Infrastructure development (transport and logistics) — critical to improving trade performance across Paraguay, South America, and LAC.
  - Governance enhancement — addressing low governance quality is key to unlocking trade potential in LAC.
  - Human capital improvement — raising human capital facilitates higher trade volumes and productivity.
- Paraguay-specific recommendations:
  - Reduce trade barriers and address infrastructure shortfalls to foster trade and economic development.
  - Enact policies to enhance Paraguay’s attractiveness for investment (to support diversification and competitiveness).
  - Strengthen collaborative trade policy efforts and multilateral cooperation within LAC.
  - Intensify diversification strategies:
    - Diversify both product mix and export markets to reduce vulnerability to external shocks.
    - Invest in agricultural technology and practices to enhance drought resilience of primary agricultural exports.
    - Develop non-agricultural export sectors to reduce reliance on volatile agricultural commodities.
    - Expand trade partnerships through new or enhanced free trade agreements to reduce market concentration risk.
  - Improve transport and logistics infrastructure to enhance competitiveness and mitigate export concentration and environmental vulnerabilities.

---

### 2. Progress through numbers (Financial inclusion)

### Recent gains and digital adoption (key statistics)
- A decade ago, about 30 percent of adults had an account at a formal financial institution (Afi, 2023).
- By 2021, this number increased to 55 percent against the NFIS’s 2018 objective of 50 percent.
- According to latest BCP data, of every 100 adults, almost 28 access credit in the formal financial system.
- Women hold about 47 percent of individual deposit accounts, most of which are savings accounts (BCP, 2023).
- COVID-19 related effects: between March and September 2020, 1.3 million new mobile wallets were opened — a growth of 78 percent.
- Paraguay is the only country in the LAC region where the share of fintech users (measured by the proportion of adults making/receiving digital payments) exceeds the proportion of traditional account holders (IMF, 2021).

### Social transfer payment modalities (selected shares)
- Food Pension Program for Seniors: payment exclusively via debit card.
- Tekoporã Program (end-2021 payment breakdown):
  - 66 percent via debit cards
  - 14 percent via counter
  - 8 percent through the National Post Office of Paraguay (DINACOPA)
  - 6 percent via electronic wallet
  - 6 percent through BNF mobile ATMs

### Global Findex 2021 usage metrics (selected entries)
- Mobile Money Account: Women 26.8; Men 30.9; Gender Gap -4.1
- Used mobile phone or internet to access an account: Women 25.1; Men 31.6; Gender Gap -6.5
- Using the internet to pay bills: Women 4.5; Men 4.3; Gender Gap 0.2
- Debit card ownership: Women 12.2; Men 18.7; Gender Gap -6.5

### Payments infrastructure and data sources
- Payment systems mentioned: Payment System for transfers in dollars and euros (LBTR), Automated clearing house (ACH), Instant Payment System (SPI), Transfers between Customers of Financial Institutions (in number of transactions).
- Source data: Central Bank of Paraguay; IMF staff calculations. Note: Data as of November 2023.

### Remaining challenges and policy directions (financial inclusion)
- Priority objectives:
  - Expand access to finance.
  - Reduce the cost of digital transactions.
  - Further promote wage and social transfer payments through accounts and digital means.
- Two access barriers highlighted:
  - Costs:
    - Worldwide, 36 percent of unbanked adults consider financial services to be too expensive (World Bank, 2021).
    - In Paraguay, more than 60 percent of unbanked adults cited cost as an impediment.
    - Proposed BCP measure: establish standard guidelines for obligatory payroll accounts free of charges for opening, maintenance, and debit card use, and without having to have a minimum account balance.
    - Complementary measures: increase competition among banks, upgrade the regulatory framework, expand cost-effective mobile services, and encourage partnerships between banks and micro-finance institutions to reduce account-holding costs.
  - Internet access:
    - At the start of 2022, roughly 37 percent of Paraguay’s population lived in rural areas.
    - Internet penetration is relatively high in Asunción and other major urban centers, while many rural communities still lack basic telecommunications services.
    - Government initiatives: Rural Telecommunications Project (aims to provide internet access to more than 1,000 rural schools and health centers) and the auction of 4G spectrum to promote competition and lower prices.
    - Need for increased investment in internet infrastructure, public Wi-Fi networks, public-private partnerships to develop broadband, and regulatory reforms to encourage new ISPs and competition.
    - Regional note: Paraguay ranks among the most expensive countries in the region in terms of fixed broadband prices (TEDIC; ECLAC, 2017).

---

### Estimating the elasticity of formality with respect to taxes and social security contributions

### Motivation and methodological overview
- Context: The informal economy remains sizeable in Paraguay; interest centers on how taxes and social security contributions affect transitions between informal and formal employment.
- Definition of informality follows Seventeenth International Conference of Labour Statisticians guidelines.
  - Identification in EPH:
    - Businesses not registered in the Single Taxpayer Registry (RUC) are part of the informal sector.
    - Businesses that employ five or fewer people and use auxiliary family workers are considered informal.
    - Informally employed individuals: those whose workplace indicates noncontribution to the retirement system; self-employed not registered in RUC; all family workers.
- Conceptual framework: probability of formal employment positively associated with net pay differential (formal minus informal) and inversely related to labor taxes.
- Empirical specification:
  - P(yn > 0)it = α + β(xf − xn)it + εit, with expected negative β for observing positive informal labor income.
  - Identification exploits tax and social security reforms and bracket creep; instruments constructed as full set of interactions between group dummies and time.
  - Grouping by gender, age, and education → 30 groups; group and time fixed effects included.

### Data and sample
- Data source: Encuesta Permanente de Hogares (EPH), years 2009 to 2022.
- Sample: Employed individuals aged 15-65 with strictly positive income from primary activity; agricultural sector omitted.
- Income reported in real terms (2001 Guaranís) and truncated at the 99th percentile.
- Note: EPH does not fully cover Boquerón, Alto Paraguay, and Presidente Hayes departments in the Chaco Region.

### Descriptive findings on incomes
- Without controls, women have a higher average income than men (negative gender wage gap in unconditional terms).
- On average, income from formal jobs and the formal sector is higher and more dispersed.
- Income distributions between informal and household sectors are relatively similar.
- Income difference densities across 30 groups: most distribution mass is above zero, but some groups have net pay higher in the informal sector than in the formal sector.

### Estimation results (selected statistics from Table 1)
- All estimates, except those in model (4) that are statistically insignificant, show the expected sign: a larger difference in net pay between formal and informal jobs reduces the proportion of informal workers.
- Baseline estimate: -1.32e-16.
- Selected elasticity estimates and t-statistics:
  - Baseline (1): -1.3e-16*  t-statistic (-2.57)
  - Robust (2): -1.3e-16**  t-statistic (-2.96)
  - Men (3): -3.6e-17  t-statistic (-1.60)
  - Women (4): 1.7e-16  t-statistic (-1.05)
  - Tertiary Educ. (5): -1.7e-16  t-statistic (-1.29)
  - Secund. Educ. (6): -1.6e-16*  t-statistic (-2.13)
  - Primary Educ (7): -4.4e-16*  t-statistic (-1.98)
  - Above Min wage (8): -2.1e-17  t-statistic (-1.59)
- Group N by model: 418, 418, 209, 209, 138, 140, 140, 412.
- Note: Dependent variable is the share of informal workers in a cell. Standard errors clustered at the cell level (except model 2, robust SEs used); delta method for SEs. * p<0.05, ** p<0.01.

### Interpretation and limitations
- Across specifications, the estimated elasticity is minimal, indicating a weak relationship between income differences and responses in formal activity.
- Interpretation: changes in taxes or social security contributions that directly impact income differences are unlikely to induce economically significant changes in the proportion of individuals with an informal job. This conclusion holds across genders and education levels and is robust to various specifications.
- Possible non-price drivers of informality include lack of benefits or awareness of benefits, poorly designed regulatory frameworks, high transaction costs, low probability of eligibility for certain benefits, and low quality/availability of services in rural areas.
- Limitations:
  - Analysis focuses on variation arising from bracket creep and does not capture all possible behavioral responses or enterprise-level informality (no enterprise survey used).
  - Workers may not recognize small tax-induced income differences; significant, clearly communicated tax parameter changes could elicit larger reactions.

### Policy recommendations (multi-pronged approach)
- General principle: Reducing or eliminating taxes and social security contributions alone may not reduce informality and could harm fiscal balances and/or provision of social services. A comprehensive combination of policies is required.
- Reduce transaction costs and procedural barriers:
  - Simplify paperwork, licensing, and registration procedures.
- Enhance visibility, quality, and perceived value of benefits:
  - Improve healthcare, accident insurance, and sickness benefits.
  - Establish an unemployment insurance scheme.
  - Introduce family allowances.
  - Broaden maternity benefits to include self-employed individuals.
  - Lower eligibility criteria for old-age benefits based on actuarial recommendations.
- Use incentive-based compliance measures at the enterprise level:
  - Link public procurement to formalizing employees and exports.
  - Require subcontractors and suppliers to formalize and maintain proper paperwork for tax clearance.
- Improve business environment and productivity growth:
  - Eliminate inefficient, complicated, and distorting rules that penalize growth in size.
  - Make targeted adjustments to tax schedules and regulations that create barriers to inclusion.
  - Enhance governmental efficiency and enforcement capacity to increase detection of informal entities and the costs of operating informally.
- Targeted support to marginal enterprises:
  - Provide targeted support leveraging national training institutes for specialized assistance to increase firm productivity and make formalization viable.
- Strengthen human capital and care supports:
  - Promote access to high-quality education and policies encouraging investment in human capital.
  - Establish comprehensive household care solutions and recognize unpaid care work to facilitate formal employment transitions.
- Evaluate non-contributory schemes and special regimes:
  - Assess how non-contributory social security systems might incentivize remaining informal and evaluate effects on productivity.
  - Ensure financial viability of pension funds so contributors have confidence that contributions yield substantial, high-quality benefits.

### Final remark
- Main conclusion: No conclusive evidence that tax incentives or reduced social security contributions alone significantly impact informality levels. The appropriate response is a holistic, efficient, growth-friendly, and fiscally sustainable policy package combining the measures above to foster formalization and support inclusive, lasting economic development.

*Source: IMF staff analysis as presented in “Analyzing Trade Barriers in Paraguay: A Comprehensive Framework for Understanding Global Integration,” Paraguay country chapter (June 10, 2024).*

### 1. Trade Pattern_________________________________________________________________________ 5

### ANAlYZING TRADE BARRIERS IN PARAGUAY: A COMPREHENSIVE FRAMEWORK FOR UNDERSTANDING GLOBAL INTEGRATION

### Trade Pattern and Recent Dynamics
- Paraguay exhibits a downward trend in both exports of goods and services and trade openness as a percentage of GDP over recent periods, while other landlocked comparator countries showed a sustained increase.
- Despite the decline, Paraguay’s levels of exports and trade openness remain above the 25th percentile of the global distribution and above those recorded for most LAC peers.
- Goods export market concentration:
  - Declined from the 2006-2009 average to 2010-2019, indicating diversification of export destinations.
  - Resurged in 2020 and declined in 2021 and 2022, reflecting a recent shift toward fewer export destinations amid reduced exports due to drought.
  - Overall goods export concentration remains below that of other landlocked countries with similar economic attributes and below the broader group of LAC countries.
- Product concentration:
  - Declined between the initial period and the subsequent decade, signaling diversification in exported products.
  - Paraguay’s product concentration is lower than similar landlocked countries and, since 2021, lower than that observed across the group of LAC countries.

### Objectives and Scope of the Study
- Aim: Assess whether Paraguay’s trade volumes are lower or higher than expected given its economic and geographical characteristics and identify non-gravity factors that may hinder integration.
- Explicitly evaluates:
  - Trade policies (tariffs and non-tariff barriers).
  - Transport infrastructure, customs efficiency, and logistics.
  - Production factor quality and access (including human capital).
  - Governance quality and business entry costs.
- Comparator groups include other LAC countries, South America, and landlocked countries similar to Paraguay (e.g., Armenia, Belarus, Botswana, Mongolia, North Macedonia, Serbia).

### Data Sources and Measures
- Goods trade flows: BACI: International Trade Database at the Product-Level (Zignago and Gaulier, 2010), reconciled at country-pair aggregate export value level for 2000 to 2021 using mirrored data from UN Comtrade.
- Gravity variables: Conte, Cotterlaz, and Mayer (2022) gravity database (bilateral distances, common language, borders, preferential trade agreements).
- Trade policy: importer’s trade MFN tariff from WITS.
- Infrastructure, logistics, and customs: World Bank Logistics Performance Index (LPI) (customs and border management efficiency; quality of trade and transport infrastructure).
- Digital infrastructure: mobile broadband subscribers per 100 people.
- Macroeconomic indicators: IMF World Economic Outlook (GDP, population).
- Human capital: Human Capital Index from Penn World Tables (PWT).
- Governance: World Governance Indicators (control of corruption, rule of law, absence of violence).

### Econometric Strategy
- Estimation method: Enhanced gravity model using Poisson pseudo-maximum likelihood (PPML) to handle zero trade flows (Santos Silva and Tenreyro, 2006).
- Specification details:
  - 푇푖,푗 denotes mean trade flow between country i and j during 2015-2019.
  - Controls include average GDP, population (POP), bilateral distance (d), dummies for common language and shared land border, landlocked status, trade policy factors (TP), logistics/customs/production factors/governance vectors (Z_i, Z_j), and PRY dummy for Paraguay partner.
  - Benchmarking includes dummies for LAC, South America, and landlocked countries similar to Paraguay.
- Estimation approach: step-by-step inclusion of variable groups following Bhattacharya and Pienknagura (2024), beginning with a basic gravity model (setting some parameters to zero) and progressively adding policy and structural variables.
- Note: Study does not estimate a fully saturated gravity model (no country-pair fixed effects); results are not framed in a structural gravity framework.

### Findings on Paraguay’s Trade Performance
- Benchmark result:
  - After accounting for key macroeconomic characteristics in the gravity model, Paraguay’s trade is estimated to be about 10 percent higher than comparable trade flows outside of Paraguay.
- Over-trading pattern:
  - Paraguay exhibits trade integration above expectations (“over-trading”) given its economic and geographic characteristics.
  - LA-7 countries also show over-trading, driven primarily by Mexico’s relationship with the US market.
  - Other landlocked countries with economic profiles akin to Paraguay also show over-trading, but less pronounced.
- Role of policy and structural variables:
  - The Paraguay over-trading result is not attributable to superior infrastructure, production factor quality, or governance; the over-trading coefficient remains largely unchanged across model specifications and increases when policy variables are added.
  - Implication: Paraguay’s elevated trade flows occur despite the country’s specific attributes, not because of them.
- Regional drivers of under-trading:
  - For LAC as a whole, deficiencies in infrastructure significantly contribute to under-trading.
  - Low governance quality is a major barrier to trade within LAC and South America.
  - Accounting for infrastructure substantially mitigates and effectively resolves the under-trading problem in South America.
  - For landlocked countries similar to Paraguay, production factors matter: when accounting for HCI and costs of initiating a business, over-trading vanishes and turns negative, implying expected trade volumes would be higher given average human capital.

### Policy Implications and Recommendations
- Cross-cutting priorities:
  - Infrastructure development (transport and logistics) — critical to improving trade performance across Paraguay, South America, and LAC.
  - Governance enhancement — addressing low governance quality is key to unlocking trade potential in LAC.
  - Human capital improvement — raising human capital facilitates higher trade volumes and productivity.
- Paraguay-specific recommendations:
  - Reduce trade barriers and address infrastructure shortfalls to foster trade and economic development.
  - Enact policies to enhance Paraguay’s attractiveness for investment (to support diversification and competitiveness).
  - Strengthen collaborative trade policy efforts and multilateral cooperation within LAC to harness benefits of greater trade openness and to manage cross-border challenges.
  - Intensify diversification strategies:
    - Diversify both product mix and export markets to reduce vulnerability to external shocks.
    - Invest in agricultural technology and practices to enhance drought resilience of primary agricultural exports.
    - Develop non-agricultural export sectors to reduce reliance on volatile agricultural commodities.
    - Expand trade partnerships through new or enhanced free trade agreements to reduce market concentration risk.
  - Improve transport and logistics infrastructure to enhance competitiveness and mitigate export concentration and environmental vulnerabilities.

### Annex I — Financial Inclusion: Marking 10 Years of Progress (summary highlights)
- Progress:
  - Paraguay has increased the percentage of adults with access to formal financial services over recent years.
  - 2013: Financial inclusion incorporated into Paraguay’s poverty reduction strategy and later into the National Financial Inclusion Strategy (NFIS) and National Development Plan.
- Key reforms and initiatives:
  - 2011: Regulation of non-banking correspondents (agents providing basic financial services).
  - 2013: Creation of a basic savings account with reduced requirements and lower fees.
  - 2014: Regulation on e-money accounts for non-bank transfers and electronic money via telecommunications.
  - 2017: Publication of gender-disaggregated information on accounts and credits provided by banks and financial companies.
  - 2022: NFIS working group for women’s financial inclusion formed (coordinated by Ministry for Women and Finance Ministry); launch of instant 24/7 interbank payment system (SPI).
  - BCP initiatives: “Financial Education for All”; expansion of banking agents in rural areas.
- Remaining challenges:
  - Limited financial literacy, high costs of financial services, and geographical barriers persist.
  - Formalization of business and financial practices identified as a principal next step in the Law on Financial Inclusion and Transparency.
- Note on SPI: Number of transactions exceeded expectations and dwarfed transactions through other payment venues (BCP, 2023).

*Source: IMF staff analysis as presented in “Analyzing Trade Barriers in Paraguay: A Comprehensive Framework for Understanding Global Integration,” Paraguay country chapter (June 10, 2024).*

### 2.      Progress through numbers. A decade ago, about 30 percent of adults had an account at a

### 2. Progress through numbers

### Financial inclusion: recent gains and digital adoption
- A decade ago, about 30 percent of adults had an account at a formal financial institution (Afi, 2023). By 2021, this number increased to 55 percent against the NFIS’s 2018 objective of 50 percent.
- According to latest BCP data, of every 100 adults, almost 28 access credit in the formal financial system.
- Women hold about 47 percent of individual deposit accounts, most of which are savings accounts (BCP, 2023).
- Paraguay’s digital financial inclusion timeline:
  - Digital financial services launched in 2008 through domestic remittances and electronic payments via mobile phones; Paraguay was a pioneer in South America.
  - Initial phase of exploration and learning: 2008-2014, when Tigo and Personal operated without dedicated regulation but in close exchange with authorities.
  - COVID-19 related effects: between March and September 2020, 1.3 million new mobile wallets were opened — a growth of 78 percent — supported by already established infrastructure.
- Paraguay is the only country in the LAC region where the share of fintech users (measured by the proportion of adults making/receiving digital payments) exceeds the proportion of traditional account holders (IMF, 2021).
- Microfinance institutions play a crucial role as providers of microloans and savings accounts to low-income individuals (Findevgetaway).
- Social transfer program payment modalities (note on Food Pension Program and Tekoporã):
  - The payment from the Food Pension Program for Seniors is now exclusively via debit card.
  - At the end of 2021, Tekoporã Program payments breakdown: 66 percent via debit cards, 14 percent via counter, 8 percent through the National Post Office of Paraguay (DINACOPA), 6 percent via electronic wallet, and 6 percent through BNF mobile ATMs.
- Usage metrics from Global Findex 2021 (selected entries as presented):
  - Mobile Money Account: Women 26.8; Men 30.9; Gender Gap -4.1
  - Used mobile phone or internet to access an account: Women 25.1; Men 31.6; Gender Gap -6.5
  - Using the internet to pay bills: Women 4.5; Men 4.3; Gender Gap 0.2
  - Debit card ownership: Women 12.2; Men 18.7; Gender Gap -6.5
  - (Table notes: Source: Global Findex 2021.)

### Payments infrastructure and transaction trends
- Payment system activity and channels mentioned include: Payment System for transfers in dollars and euros (LBTR), Automated clearing house (ACH), Instant Payment System (SPI), Transfers between Customers of Financial Institutions (in number of transactions).
- Source data: Central Bank of Paraguay; IMF staff calculations. Note: Data as of November 2023.

### Remaining challenges and policy directions
- Priority objectives:
  - Expand access to finance.
  - Reduce the cost of digital transactions.
  - Further promote wage and social transfer payments through accounts and digital means.
- Two access barriers highlighted for Paraguay:
  - Costs:
    - Worldwide, 36 percent of unbanked adults consider financial services to be too expensive (World Bank, 2021).
    - In Paraguay, more than 60 percent of unbanked adults cited cost as an impediment.
    - Proposed BCP measure: establish standard guidelines for obligatory payroll accounts free of charges for opening, maintenance, and debit card use, and without having to have a minimum account balance.
    - Suggested complementary measures: increase competition among banks, upgrade the regulatory framework, expand cost-effective mobile services, and encourage partnerships between banks and micro-finance institutions to reduce account-holding costs.
  - Internet access:
    - Progress in access to finance now depends on the mobile phone more than the banking system; ubiquitous and affordable internet access is a prerequisite.
    - At the start of 2022, roughly 37 percent of Paraguay’s population lived in rural areas.
    - Internet penetration is relatively high in Asunción and other major urban centers, while many rural communities still lack basic telecommunications services.
    - Government initiatives: Rural Telecommunications Project (aims to provide internet access to more than 1,000 rural schools and health centers) and the auction of 4G spectrum to promote competition and lower prices.
    - Need for increased investment in internet infrastructure, public Wi-Fi networks, public-private partnerships to develop broadband, and regulatory reforms to encourage new ISPs and competition.
- Regional price note: Paraguay ranks among the most expensive countries in the region in terms of fixed broadband prices (TEDIC; ECLAC, 2017).

---

### Estimating the elasticity of formality with respect to taxes and social security contributions

### Motivation and context
- The informal economy remains sizeable in Paraguay despite recent progress in growth and poverty reduction; a significant portion of the population lacks access to formal labor and social protection.
- Policy interest: understanding how taxes and social security contributions affect transitions between informal and formal employment.
- Literature overview highlights:
  - Ulyssea (2020) and Cetrangolo and Calligaro (2023): increasing enforcement is more effective to reduce informality than lowering costs of formality.
  - Global evidence: tax reductions can induce formalization but with low elasticity and potential net tax revenue losses.
  - Mixed evidence for Latin America; Paraguay-specific evidence is scant.
  - Examples cited: Rocha et al. (2018) (reducing payroll taxes reduced firm informality but implied low elasticity), De Andrade et al. (2013) (no evidence that reducing costs incentivizes formalization; inspections matter), Kugler and Kugler (2009) (10 percent increase in payroll taxes led to 4-5 percent decrease in formal employment in Colombia), Morales and Medina (2017) (13.5 percent reduction in payroll taxes increased formal employment).
  - Calibration and theoretical models suggest government effectiveness, penalties, regulatory burdens, and formal-sector benefits affect formality.

### Defining informality (methodology used)
- Adopt Seventeenth International Conference of Labour Statisticians guidelines for statistical definition of informal employment.
- Identification in EPH:
  - Businesses not registered in the Single Taxpayer Registry (RUC) are part of the informal sector.
  - Businesses that employ five or fewer people and use auxiliary family workers are considered informal.
  - Informally employed individuals: those whose workplace indicates noncontribution to the retirement system; self-employed not registered in RUC; all family workers.
- Notes:
  - When respondents are unsure about RUC compliance, establishment size and legal status are used to determine informality.
  - Self-employed can register for RUC via three options and may voluntarily contribute to social security; very few register and the voluntary scheme attracts less than 1,000 contributors.

### Conceptual framework and identification
- Framework based on McKay et al. (2019), Jäntti et al. (2015), Blundell et al. (1998):
  - Individuals choose informal employment depending on formal-sector job availability.
  - Formal sector workers receive earnings net of taxes and acquire benefits (healthcare, pension entitlements); informal sector workers do not pay taxes and forgo those benefits.
  - Likelihood of formal employment positively associated with net pay differential (formal minus informal) and inversely related to labor taxes.
- Empirical specification (as stated):
  - P(yn > 0)it = α + β(xf − xn)it + εit, with expected negative β for observing positive informal labor income.
  - Identification exploits tax and social security reforms and bracket creep; instruments constructed as full set of interactions between group dummies and time (group-time means used as excluded instruments).
  - Grouping by gender, age, and education aligns with prior literature; group and time fixed effects included.
  - Elasticity expression (as given): β × [ (xf − xn)̅ / P(yf > 0)̅ ] with group-level clustering and delta method standard errors; cannot use log specification because income differences may be negative.

### Data, descriptive statistics, and sample construction
- Data source: Encuesta Permanente de Hogares (EPH), years 2009 to 2022.
- Sample:
  - Employed individuals aged 15-65 with strictly positive income from primary activity; agricultural sector omitted.
  - Grouping: gender, education (primary, secondary, tertiary), and five ten-year age groups → 30 groups.
  - Income reported in real terms (2001 Guaranís) and truncated at the 99th percentile.
  - Note: EPH does not fully cover Boquerón, Alto Paraguay, and Presidente Hayes departments in the Chaco Region.
- Descriptive findings:
  - Density estimates (Epanechnikov Kernel) of monthly net income by gender, sector, and job show:
    - Without controls, women have a higher average income than men, implying a negative gender wage gap in unconditional terms.
    - On average, income from formal jobs and the formal sector is higher and more dispersed.
    - Income distributions between informal and household sectors are relatively similar.
  - Income difference densities (30 groups): most distribution mass is above zero, but some groups have net pay higher in the informal sector than in the formal sector.

### Results and estimation notes
- Table 1 (described, not reproduced here) presents elasticity estimates of informal work for Paraguay using the grouped estimator (equation (2)):
  - Column structure described:
    - Column (1): preferred specification (baseline).
    - Column (2): same specification with heteroscedasticity-robust standard errors instead of clustering at cell level.
    - Columns (3)-(7): preferred specification estimates for several sub-samples.
    - Column (8): sample excluding observations below the minimum wage due to differing incentive structures.
- Additional methodological points:
  - Clustering at the group level; standard errors calculated using the delta method.
  - Note on minimum wage: a binding minimum wage could prevent workers from requesting a higher wage in response to tax changes.

*Source: IMF staff chapter text (EPH, Central Bank of Paraguay, Global Findex, BCP, and cited literature).*

### 21.      All estimates, except those in the model (4) that are statistically insignificant, show the

### E. Policy Implications

### Key empirical findings on informality and income differences
- All estimates, except those in the model (4) that are statistically insignificant, show the expected sign: a larger difference in net pay between formal and informal jobs reduces the proportion of informal workers.
- Baseline estimate: -1.32e-16.
- Most estimates are statistically different from zero; some subgroup estimates are less precise due to smaller sample size but are similar in magnitude.
- Across specifications, the estimated elasticity is minimal, indicating a weak relationship between income differences and responses in formal activity.
- Interpretation: changes in taxes or social security contributions that directly impact income differences are unlikely to induce economically significant changes in the proportion of individuals with an informal job. This conclusion holds across genders and education levels and is robust to various specifications.
- Possible non-price drivers of informality include lack of benefits or awareness of benefits, poorly designed regulatory frameworks, high transaction costs (procedural or implementation difficulties), low probability of eligibility for certain benefits, and low quality/availability of services in rural areas.
- Evidence from other countries supports the importance of benefit visibility and access: Uruguay (Bergolo and Cruces, 2014) — extending healthcare coverage increased registered employment; Mexico — Popular Health Insurance program reduced registered employers by 3.8 percent and employees by 2.4 percent (Bosch and Campos-Vazquez, 2014).

### Paraguay: Regression results (selected statistics from Table 1)
- Elasticity estimates:
  - Baseline (1): -1.3e-16*  t-statistic (-2.57)
  - Robust (2): -1.3e-16**  t-statistic (-2.96)
  - Men (3): -3.6e-17  t-statistic (-1.60)
  - Women (4): 1.7e-16  t-statistic (-1.05)
  - Tertiary Educ. (5): -1.7e-16  t-statistic (-1.29)
  - Secund. Educ. (6): -1.6e-16*  t-statistic (-2.13)
  - Primary Educ (7): -4.4e-16*  t-statistic (-1.98)
  - Above Min wage (8): -2.1e-17  t-statistic (-1.59)
- Group N by model: 418, 418, 209, 209, 138, 140, 140, 412.
- Note: The dependent variable is the share of informal workers in a cell. The elasticity is of informal work with respect to changes in the difference of formal versus informal wage. Standard errors are clustered at the cell level (except model 2, where robust standard errors are used), and calculated by the delta method. * p<0.05, ** p<0.01.

### Policy recommendations (multi-pronged approach)
- General principle: Reducing or eliminating taxes and social security contributions alone may not reduce informality and could harm fiscal balances and/or provision of social services. A comprehensive combination of policies is required.
- Reduce transaction costs and procedural barriers:
  - Simplify paperwork to make formal employment more accessible.
  - Simplify licensing and registration procedures.
- Enhance visibility, quality, and perceived value of benefits:
  - Improve healthcare, accident insurance, and sickness benefits (since old-age and invalidity pensions do not provide immediate incentives).
  - Establish an unemployment insurance scheme.
  - Introduce family allowances.
  - Broaden maternity benefits to include self-employed individuals.
  - Lower eligibility criteria for old-age benefits based on actuarial recommendations so contributors can qualify earlier.
- Use incentive-based compliance measures at the enterprise level:
  - Link public procurement to formalizing employees and exports.
  - Require subcontractors and suppliers to formalize and maintain proper paperwork for tax clearance.
- Improve business environment and productivity growth:
  - Eliminate inefficient, complicated, and distorting rules that penalize growth in size (e.g., indirect taxes on larger/formal entities).
  - Make targeted adjustments to tax schedules and regulations that create barriers to inclusion.
  - Enhance governmental efficiency and enforcement capacity to increase detection of informal entities and the costs of operating informally.
- Targeted support to marginal enterprises:
  - Provide targeted support leveraging national training institutes for specialized assistance to increase firm productivity and make formalization viable.
- Strengthen human capital and care supports:
  - Promote access to high-quality education and policies encouraging investment in human capital.
  - Establish comprehensive household care solutions to mitigate underemployment and pullout from the labor force.
  - Recognize and address unpaid care work to facilitate formal employment transitions for workers in this sector.
- Evaluate non-contributory schemes and special regimes:
  - Assess how non-contributory social security systems might incentivize remaining informal and evaluate their effects on productivity.
  - Ensure financial viability of pension funds so contributors have confidence that contributions yield substantial, high-quality benefits.

### Limitations, complementarities, and final remarks
- The analysis focuses on variation in taxation arising primarily from adjustments in income levels that determine tax bracket thresholds (bracket creep); workers might not always recognize these differences.
- Significant, clearly communicated alterations to tax parameters could elicit more pronounced, non-linear reactions than those observed.
- Analysis presumes incentives are designed for individual workers choosing between formal and informal engagement; informality also occurs at the enterprise level — the analysis does not use an enterprise survey and thus is limited in this dimension.
- Main conclusion: The research finds no conclusive evidence that tax incentives or reduced social security contributions alone significantly impact informality levels. Given the need for domestic revenue to fund social programs and invest in human capital and productivity, the appropriate response is a holistic, efficient, growth-friendly, and fiscally sustainable policy package combining the measures above to foster formalization and support inclusive, lasting economic development.

*Source: Paraguay — International Monetary Fund (selected excerpts).*

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_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1pryea2024003-print-pdf.pdf_