This paper proposes an empirical investigation of the effect of trade liberalization on
informality in Egypt. The literature does not indicate a clear relationship between informality
and trade liberalization. While some studies find that it is more profitable to enter the formal
sector rather to remain informal when trade openness increases, others argue that trade
liberalization may lead to an increase in informality. This effect of trade liberalization on the
informal sector has been widely discussed at both empirical and public policy levels but was
never tested empirically in Egypt. Thus, combining a microeconomic dataset (the Egyptian
Labor Market Panel Survey) with some macroeconomic variables (tariffs), we try to assess to
what extent trade reforms affected the informal sector in Egypt. Our main findings show that
trade liberalization has indeed decreased informality in Egypt. In fact, trade liberalization (i.e.
lower trade costs) implies that some firms will find it more profitable to enter the formal
sector rather to remain informal. The least productive informal firms will be forced to exit the
industry and only the most productive (formal) firms will export to international markets.
Moreover, the degree of labor market flexibility associated to the labor reform of 2003 is
likely to be one of the reasons behind this change.