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The informal sector, informal economy, or grey economy is the part of an economy that is not taxed, nor monitored by any form of government. Unlike the formal economy, activities that are engaged in the informal economy are not included in the gross national product (GNP) and gross domestic product (GDP) of a country.
Other terms used to refer to the informal sector can include the black market, the shadow economy, the underground economy, the agora, and System D. Associated idioms include "under the table", "off the books" and "working for cash".
Although the informal sector makes up a significant portion of the economies in developing countries – about 41% in 2000 according to the official GNI metric – it is often stigmatized as troublesome and unmanageable. However the informal sector provides critical economy opportunities for the poor and has been expanding rapidly since the 1960s. As such, integrating the informal economy into the formal sector is an important policy challenge.
- 1 Definition
- 2 History
- 3 Statistics
- 4 "The Shadow Economy in Europe 2013"
- 5 Social and political implications and issues
- 6 Expansion and growth
- 7 Policy suggestions
- 8 See also
- 9 References
- 10 Further reading
- 11 External links
The original use of the term ‘informal sector’ is attributed to the economic development model put forward by W. Arthur Lewis, used to describe employment or livelihood generation primarily within the developing world. It was used to describe a type of employment that was viewed as falling outside of the modern industrial sector. An alternative definition uses job security as the measure of formality, defining participants in the informal economy as those 'who do not have employment security, work security and social security.” While both of these definitions imply a lack of choice or agency in involvement with the informal economy, participation may also be driven by a wish to avoid regulation or taxation. This may manifest as unreported employment, hidden from the state for tax, social security or labour law purposes, but legal in all other aspects.
The term is also useful in describing and accounting for forms of shelter or living arrangements that are similarly unlawful, unregulated, or not afforded protection of the state. ‘Informal economy’ is increasingly replacing ‘informal sector’ as the preferred descriptor for this activity.
Informality, both in housing and livelihood generation has often been seen as a social ill, and described either in terms of what participant’s lack, or wish to avoid. A countervailing view, put forward by prominent Dutch sociologist Saskia Sassen is that the modern or new ‘informal’ sector is the product and driver of advanced capitalism and the site of the most entrepreneurial aspects of the urban economy, led by creative professionals such as artists, architects, designers and soft-ware developers. While this manifestation of the informal sector remains largely a feature of developed countries, increasingly systems are emerging to facilitate similarly qualified people in developing countries to participate
The informal sector is largely characterized by several qualities: easy entry, meaning anyone who wishes to join the sector can find some sort of work which will result in cash earnings, a lack of stable employer-employee relationships, a small scale of operations, and skills gained outside of a formal education. Workers who participate in the informal economy are typically classified as employed. The type of work that makes up the informal economy is diverse, particularly in terms of capital invested, technology used, and income generated. The spectrum ranges from self-employment or unpaid family labor to street vendors, shoe shiners, and junk collectors. On the higher end of the spectrum are upper-tier informal activities such as small-scale service or manufacturing businesses, which have more limited entry. The upper-tier informal activities have higher set-up costs, which might include complicated licensing regulations, and irregular hours of operation. However, most workers in the informal sector, even those are self-employed or wage workers, do not have access to secure work, benefits, welfare protection, or representation. These features differ from businesses and employees in the formal sector which have regular hours of operation, a regular location and other structured benefits.
The most prevalent types of work in the informal economy are home-based workers and street vendors. Home-based workers are more numerous while street vendors are more visible. Combined, the two fields make up about 10-15% of the non-agricultural workforce in developing countries and over 5% of the workforce in developed countries.
While participation in the informal sector can be stigmatized, many workers engage in informal ventures by choice, for either economic or non-economic reasons. Economic motivations include the ability to evade taxes, the freedom to circumvent regulations and licensing requirements, and the capacity to maintain certain government benefits. A study of informal workers in Costa Rica illustrated other economic reasons for staying in the informal sector, as well as non-economic factors. First, they felt they would earn more money through their informal sector work than at a job in the formal economy. Second, even if workers made less money, working in the informal sector offered them more independence, the chance to select their own hours, the opportunity to work outside and near friends, etc. While jobs in the formal economy might bring more security and regularity, or even pay better, the combination of monetary and psychic rewards from working in the informal sector proves appealing for many workers.
The informal sector was historically recognized as an opposition to formal economy, meaning it included all income earning activities beyond legally regulated enterprises. However, this understanding is too inclusive and vague, and certain activities that could be included by that definition are not considered part of the informal economy. As the International Labor Organization defined the informal sector in 2002, the informal sector does not include the criminal economy. While production or employment arrangements in the informal economy may not be strictly legal, the sector produces and distributes legal goods and services. The criminal economy produces illegal goods and services. The informal economy also does not include the reproductive or care economy, which is made up of unpaid domestic work and care activities. The informal economy is part of the market economy, meaning it produces goods and services for sale and profit. Unpaid domestic work and care activities do not contribute to that, and as a result, are not a part of the informal economy.
Governments have tried to regulate (formalize) aspects of their economies for as long as surplus wealth has existed which is at least as early as Sumer. Yet no such regulation has ever been wholly enforceable. Archaeological and anthropological evidence strongly suggests that people of all societies regularly adjust their activity within economic systems in attempt to evade regulations. Therefore, if informal economic activity is that which goes unregulated in an otherwise regulated system then informal economies are as old as their formal counterparts, if not older. The term itself, however, is much more recent. The optimism of the modernization theory school of development had led most people in the 1950s and 1960s to believe that traditional forms of work and production would disappear as a result of economic progress in developing countries. As this optimism proved to be unfounded, scholars turned to study more closely what was then called the traditional sector. They found that the sector had not only persisted, but in fact expanded to encompass new developments. In accepting that these forms of productions were there to stay, scholars began using the term informal sector, which is credited to the British anthropologist Keith Hart in a study on Ghana in 1973 but also alluded to by the International Labour Organization in a widely read study on Kenya in 1972.
Since then the informal sector has become an increasingly popular subject of investigation, not just in economics, but also in sociology, anthropology and urban planning. With the turn towards so called post-fordist modes of production in the advanced developing countries, many workers were forced out of their formal sector work and into informal employment. In a seminal collection of articles, The Informal Economy. Studies in Advanced and Less Developed Countries, Alejandro Portes and collaborators emphasized the existence of an informal economy in all countries by including case studies ranging from New York City and Madrid to Uruguay and Colombia.
Arguably the most influential book on informal economy is Hernando de Soto's El otro sendero (1986), which was published in English in 1989 as The Other Path with a preface by Peruvian writer Mario Vargas Llosa. De Soto and his team argue that excessive regulation in the Peruvian (and other Latin American) economies force a large part of the economy into informality and thus prevent economic development. While accusing the ruling class of 20th century mercantilism, de Soto admires the entrepreneurial spirit of the informal economy. In a widely cited experiment, his team tried to legally register a small garment factory in Lima. This took more than 100 administrative steps and almost a year of full-time work. Whereas de Soto's work is popular with policymakers and champions of free market policies like The Economist, many scholars of the informal economy have criticized it both for methodological flaws and normative bias.
In the second half of the 1990s many scholars have started to consciously use the term "informal economy" instead of "informal sector" to refer to a broader concept that includes enterprises as well as employment in developing, transition, and advanced industrialized economies.
The informal economy under any governing system is diverse and includes small-scaled, occasional members (often street vendors and garbage recyclers) as well as larger, regular enterprises (including transit systems such as that of Lima, Peru). Informal economies include garment workers working from their homes, as well as informally employed personnel of formal enterprises. Employees working in the informal sector can be classified as wage workers, non-wage workers, or a combination of both.
Statistics on the informal economy are unreliable by virtue of the subject, yet they can provide a tentative picture of its relevance: For example, informal employment makes up 48% of non-agricultural employment in North Africa, 51% in Latin America, 65% in Asia, and 72% in sub-Saharan Africa. If agricultural employment is included, the percentages rise, in some countries like India and many sub-Saharan African countries beyond 90%. Estimates for developed countries are around 15%.
In developing countries, the largest part of informal work, around 70%, is self-employed. Wage employment predominates. The majority of informal economy workers are women. Policies and developments affecting the informal economy have thus a distinctly gendered effect.
Estimated size of countries' informal economy
The table below shows the estimated values of the size of the informal economy in 110 developing, transition and OECD countries.
in % of GNP
|Bosnia and Herzegovina||1.6||34.1|
|United Arab Emirates||0.0||26.4|
|Hong Kong, China||27.5||16.6|
"The Shadow Economy in Europe 2013"
Direct comparison of the national shadow economies per capita can be done if national raw data of shadow economies and populations are considered. They are available from "The Shadow Economy in Europe 2013", pp.22-23, Friedrich Schneider, University of Linz, and from EUROSTAT, respectively. As a result in some national economies, like in Scandinavian countries, their informal part seems to be low compared to the GDP although the absolute number is very high. Obviously, the country's extremely high GDP covers its high shadow economy. On the other hand in countries where GDP is very low, like Portugal and Greece, the shadow economy is overestimated. The 2013 European shadow economy map clearly demonstrates that generally shadow economy per capita is high in industrially developed countries.
Social and political implications and issues
According to development and transition theories, workers in the informal sector typically earn less income, have unstable income, and do not have access to basic protections and services. The informal economy is also much larger than most people realize, with women playing a huge role. The working poor, particularly women, are concentrated in the informal economy, and most low-income households rely on the sector to provide for them. However, informal businesses can also lack the potential for growth, trapping employees in menial jobs indefinitely. On the other hand the informal sector can allow a large proportion of the population to escape extreme poverty and earn an income that is satisfactory for survival. Also, in developed countries, some people who are formally employed may choose to perform part of their work outside of the formal economy, exactly because it delivers them more advantages. This is called 'moonlighting'. They derive social protection, pension and child benefits and the like, from their formal employment, and at the same time have tax and other advantages from working on the side.
From the viewpoint of governments, the informal sector can create a vicious cycle. Being unable to collect taxes from the informal sector, the government may be hindered in financing public services, which in turn makes the sector more attractive. Conversely, some governments view informality as a benefit, enabling excess labor to be absorbed, and mitigating unemployment issues. Recognizing that the informal economy can produce significant goods and services, create necessary jobs, and contribute to imports and exports is critical for governments.
Women tend to make up the greatest portion of the informal sector, often ending up in the most erratic and corrupt segments of the sector. Sixty percent of female workers in developing countries are employed by the informal sector. A vast majority of women are employed from their homes (most likely due to the large number of women who are involved in care work) or are street vendors, which both are classified in the informal sector.
Female representation in the informal sector is attributed to a variety of factors. One such factor is the fact that employment in the informal sector is the source of employment that is most readily available to women. A 2011 study of poverty in Bangladesh noted that cultural norms, religious seclusion, and illiteracy among women in many developing countries, along with a greater commitment to family responsibilities, prevent women from entering the formal sector.
According to a 2002 study commissioned by the ILO, the connection between employment in the informal economy and being poor is stronger for women than men. While men tend to be overrepresented in the top segment of the informal sector, women overpopulate the bottom segment. Men are more likely to have larger scale operations and deal in non-perishable items while few women are employers who hire others. Instead, women are more likely to be involved in smaller scale operations and trade food items. Women are under-represented in higher income employment positions in the informal economy and over-represented in lower income statuses. As a result, the gender gap in terms of wage is even higher in the informal sector than the formal sector. Labor markets, household decisions, and states all propagate this gender inequality.
Political power of agents
Workers in the informal economy lack a significant voice in government policy. Not only is the political power of informal workers limited, but the existence of the informal economy creates challenges for other politically influential actors. For example, the informal workforce is not a part of any trade union, nor does there seem a push or inclination to change that status. Yet the informal economy negatively affects membership and investment in the trade unions. Laborers who might be formally employed and join a union for protection may choose to branch out on their own instead. As a result, trade unions are inclined to oppose the informal sector, highlighting the costs and disadvantages of the system. Producers in the formal sector can similarly feel threatened by the informal economy. The flexibility of production, low labor and production costs, and bureaucratic freedom of the informal economy can be seen as consequential competition for formal producers, leading them to challenge and object to that sector. Last, the nature of the informal economy is largely anti-regulation and free of standard taxes, which diminishes the material and political power of government agents. Whatever the significance of these concerns are, the informal sector can shift political power and energies.
The relationship between the informal sectors and poverty certainly isn’t simple nor does a clear, causal relationship exist. An inverse relationship between an increased informal sector and slower economic growth has been observed though.
Average incomes are substantially lower in the informal economy and there is a higher preponderance of impoverished employees working in the informal sector. In addition, workers in the informal economy are less likely to benefit from employment benefits and social protection programs.
Expansion and growth
The informal sector has been expanding as more economies have started to liberalize. This pattern of expansion began in the 1960s when a lot of developing countries didn’t create enough formal jobs in their economic development plans, which led to the formation of an informal sector that didn’t solely include marginal work and actually contained profitable opportunities. In the 1980s, the sector grew alongside formal industrial sectors. In the 1990s, an increase in global communication and competition led to a restructuring of production and distribution, often relying more heavily on the informal sector. Over the past decade, the informal economy is said to account for more than half of the newly created jobs in Latin America. In Africa it accounts for around eighty percent. Many explanations exist as to why the informal sector has been expanding in the developing world throughout the past few decades. It is possible that the kind of development that has been occurring has failed to support the increased labor force in a formal manner. Expansion can also be explained by the increased subcontracting due to globalization and economic liberalization. Finally, employers could be turning toward the informal sector to lower costs and cope with increased competition.
According to the Swedish International Development Cooperation Agency (SIDA), the key drivers for the growth of the informal economy in the twenty-first century include:
- limited absorption of labour, particularly in countries with high rates of population or urbanisation;
- excessive cost and regulatory barriers of entry into the formal economy, often motivated by corruption;
- weak institutions, limiting education and training opportunities as well as infrastructure development;
- increasing demand for low-cost goods and services;
- migration motivated by economic hardship and poverty; and
- difficulties faced by women in gaining formal employment
Historically, development theories have asserted that as economies mature and develop, economic activity will shift from the informal to the formal sphere. In fact, much of the economic development discourse is centered around the notion that formalization indicates how developed a country's economy is. However, evidence suggests that the progression from informal to formal sectors is not universally applicable. While the characteristics of a formalized economy - full employment and an extensive welfare system - have served as effective methods of organizing work and welfare for some nations, such a structure is not necessarily inevitable or ideal. Indeed, development appears to be heterogeneous in different localities, regions, and nations, as well as the type of work practiced. For example, at one end of the spectrum of the type of work practiced in the informal economy are small-scale businesses and manufacturing; on the other "street vendors, shoe shiners, junk collectors and domestic servants." Regardless of how the informal economy develops, its continued growth that it cannot be considered a temporary phenomenon.
As it has been historically stigmatized, policy perspectives viewed the informal sector as disruptive to the national economy and a hindrance to development. The justifications for such criticisms include viewing the informal economy as a fraudulent activity that results in a loss of revenue from taxes, weakens unions, creates unfair competition, leads to a loss of regulatory control on the government's part, reduces observance of health and safety standards, and reduces the availability of employment benefits and rights. These characteristics have led to many nations pursuing a policy of deterrence with strict regulation and punitive procedures.
- Markets function efficiently on their own; government interference would only lead to inefficiency and dysfunction.
- The informal economy functions outside of government control, largely because those who participate wish to avoid regulation and taxation.
- The informal economy is enduring; suitable regulation and policies are required.
As informal economy has significant job creation and income generation potential, as well as the capacity to meet the needs of poor consumers by providing cheaper and more accessible goods and services, many stakeholders subscribe to the third perspective and support government intervention and accommodation. Embedded in the third perspective is the significant expectation that governments will revise policies that have favored the formal sphere at the expense of informal sector.
Theories of how to accommodate the informal economy argue for government policies that, recognizing the value and importance of the informal sector, regulate and restrict when necessary but generally work to improve working conditions and increase efficiency and production.
The challenge for policy interventions is that so many different types of informal work exist; a solution would have to provide for a diverse range of circumstances. A possible strategy would be to provide better protections and benefits to informal sector players. However, such programs could lead to a disconnect between the labor market and protections, which would not actually improve informal employment conditions. In a 2014 report monitoring street vending, WIEGO suggested urban planners and local economic development strategists study the carrying capacity of areas regularly used by informal workers and deliver the urban infrastructure necessary to support the informal economy, including running water and toilets, street lights and regular electricity, and adequate shelter and storage facilities. That study also called for basic legal rights and protections for informal workers, such as appropriate licensing and permit practices.
An ongoing policy debate considers the value of government tax breaks for household services such cleaning, babysitting and home maintenance, with an aim to reduce the shadow economy's impact. There are currently systems in place in Sweden and France which offer 50 percent tax breaks for home cleaning services. There has also been debate in the UK about introducing a similar scheme, with potentially large savings for middle-class families and greater incentive for women to return to work after having children. The European Union has used political measures to try and curb the shadow economy. Although no definitive solution has been established to date, the EU council has led dialogue on a platform that would combat undeclared work. There has also been media coverage surrounding new e-commerce models. The debate has also discussed whether new on-demand home service businesses like Instacart and Helpling could attract workers who had previously earned ‘cash-in-hand’ within the shadow economy.
- Casual employment
- Doing business as
- Hernando de Soto
- International Labour Organization
- Keith Hart
- Legal personality, a requirement for legitimate businesses
- Rotating Savings and Credit Association
- System D
- Virtual economy
- Informal housing
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- UNRISD. 2010. “Gender Inequalities at Home and in the Market.” Assignment: Chapter 4, pp. 5-33.
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- Cheats or Contributors? Self Employed People in the Informal Economy A report by east London Charity Community Links and Microfinance organisation Street UK providing analysis of the motivations of informal workers.
- Need not Greed - People in low-paid informal work A report by east London Charity Community Links explores the experience of people on low incomes, doing informal paid work.
- World Bank policy note on The Informality Trap: Tax Evasion, Finance, and Productivity in Brazil
- World Bank policy note on Rising Informality - Reversing the Tide
- Paper estimating the size of the informal economy in 110 developing, transition and developed countries
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