I have blogged earlier about the high, often prohibitive, costs associated with formality in manufacturing, labor market, and real estate. In simple terms, in the absence of any reduction in complementary costs, formality introduces layers of compliance costs which the demand side in these markets cannot support. All sides to transactions in these sectors, therefore, prefer to keep them informal.
The MR folks point to a paper by Sebastian Galiani and Ernesto Schargrodsky, who studied a natural experiment involving allocation of land titles to very poor families in the suburbs of Buenos Aires, and found similar costs associated with formal land titling,
Although previous studies on this experiment have found important effects of titling on investment, household structure, educational achievement, and child health, in this article we document that a large fraction of households that went through a situation at which formalization was challenged (death, divorce, sale/purchase), ended up being de-regularized. The legal costs of remaining formal seem too high relative to the value of these parcels and the income of their inhabitants... The cost of processing the inheritance of an asset valued at US$ 11,700 is about US$ 2,300... When property rights are transferred to very poor people, preserving legal tenure will likely entail onerous expenses in the form of attorney and public notary fees, and courts costs. In addition, these charges are higher in relative terms in very unequal societies where the gap between the poor and the relatively well-off is wider.
These low-level informality equilibriums are rarely ever broken with regulatory changes. They require economy-wide changes whose benefits by way of lowering the cost of transactions offsets the increased cost associated with going formal.