The Unintended Consequences of Place-Based Industrial Policies: Evidence from Colombia

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This paper examines the local economic impact of Colombia’s Free Economic Zones (FEZs) program, implemented between 2005 and 2018. Using a novel dataset that integrates georeferenced data on FEZs, municipalities, household characteristics, and firms, I analyze the spatial effects of these zones on labor markets and firm dynamics, with a particular focus on informality. The findings reveal that FEZs significantly increase informality, with spillover effects on nearby regions but minimal impact on overall employment. While they create formal job opportunities for skilled workers and women, low-skilled workers face rising informality and wage losses. Empirically, I show that FEZs boost the profitability of high-productivity formal firms, enabling them to raise wages and expand employment. However, this also raises labor costs, forcing low-productivity formal firms to exit and increasing the productivity threshold for formal firm entry, ultimately leading to higher informality. Building on these results, I aim to develop a structural model to further rationalize and quantify these mechanisms.