Playing by the Rules: Is Business Formality Driving Economic Growth? Evidence From Colombia's Capital Cities

ABSTRACT This paper contributes to the literature on the effects of institutions on economic growth by addressing a topic that has been little explored. Specifically, it uses Colombia's capital cities as a case study for the period 2007–2020 to examine the impact of business formality on local economic performance. To do so, an ad hoc variable is constructed to be incorporated into a beta convergence growth approach. The model, estimated using GLS and GMM techniques, yields quite robust results, indicating that increased formality has significantly raised per capita income. Additionally, the findings show a reduction in disparities among urban centers in Colombia, with a convergence speed that is by no means negligible. Finally, a spatial GMM framework is proposed to capture the potential influence of neighboring cities. This new approach confirms, on one hand, the role of formalization in stimulating productive activity, and on the other hand, underscores that the convergence process is driven not only by city‐specific factors but also by inter‐city relationships, particularly spillover effects from wealthier urban areas.