About the Informal Economy

Policy Debates and Responses

Linked to the theoretical debates on the informal economy is a policy debate on whether and how governments should regulate the informal economy. One policy approach, championed by Hernando de Soto, argues for reducing the burden of bureaucracy that leads entrepreneurs to operate informally and for extending the ‘rule of law’, in particular property rights, so that informal entrepreneurs can convert their informal assets into real assets (de Soto 2000, 1989). Another policy approach, promoted by Alejandro Portes and others who take a structuralist view, sees a government role in regulating the imbalance of power within market or, more specifically, the unequal relationship between “big business” and informal enterprises or informal workers. A third approach, promoted by the ILO under the rubric of “Decent Work”, sees a government role in promoting economic opportunities, economic rights, social protection, and social dialogue (between government, employers, and workers) for all types of workers, both formal and informal.

At the core of these policy debates is the oft-repeated question of whether the informal economy should be “formalized”. However, it is not always clear what is meant by formalization or whether formalization is desirable or feasible. Formalization has different meanings for different segments of the informal economy.

• formalization of informal enterprises: requires bureaucracies that are willing and able to simplify registration requirements, introduce progressive registration fees, and offer very small businesses the incentives and benefits that large formal businesses receive.
  
• formalization of informal jobs: requires extension of legal and social protection to informal workers and creation of more formal jobs
  
  

However, in most countries, registration requirements are cumbersome, transaction costs are high, and economic policies and incentives are biased towards larger enterprises in most countries. Further, in many countries, employment growth is not keeping pace with the demand for jobs – there simply are not enough formal jobs to go around. And employers are more inclined to convert formal jobs into informal jobs – rather than the other way around.

For a more detailed analysis of the formalization debate, see chapter by Marty Chen in the forthcoming edited volume by Guha-Khasnobis, Kanbur, and Ostrom., Unlocking Human Potential: Formality and Informality in Developing Countries.

Given that informal employment appears to be a widespread and persistent feature of today’s global economy, what is needed is a policy framework that seeks to:

• expand formal employment by putting employment creation and decent work at the centre of macroeconomic policy;
  
• increase efforts to a) formalize informal enterprises by creating incentives and simplifying procedures for entrepreneurs to register and b) formalize informal jobs by persuading employers to provide more benefits and protections to their workers; and
  
• increase the returns to their investment of those who work in the informal economy by increasing their assets and competitiveness and by assuring better terms and conditions of work (Diez de Medina 2005 and Chapter 6 of UNIFEM’s Progress of the World’s Women 2005: Women, Work and Poverty.

For the component strategies of such a policy approach, see:

Chapter 6 of the UNIFEM’s Progress of the World’s Women 2005: Women, Work and Poverty.

Chapter 5 of Commonwealth Secretariat’s Mainstreaming Informal Employment
and Gender in Poverty Reduction (Chen et al 2004)

ILO Report on Decent Work and the Informal Economy

For good practice examples of policy responses - as well as responses by non-governmental organizations and the private sector – to the informal economy, see:

Chapters 5 and 6 of UNIFEM’s 2005 Progress of the World’s Women: Women, Work, and Poverty (Chen et al 2005)

Chapter 4 of Commonwealth Secretariat’s Mainstreaming Informal Employment
and Gender in Poverty Reduction Chen et al 2004)