Informality & Growth: Summary of Recent Analyses

James Heintz and Robert Pollin 20021

  • source and type of data:  
    • ILO data: national labour force survey - time-series (1990-1997) 
    • Charmes data: national labour force and enterprise surveys - single point in time 
  • definition of informality:
    • ILO data: employment in small firms + self-employment
    • Charmes data: all employment outside formal firms (residual method)
  • number of countries:
    • ILO data: 14 Latin American countries
    • Charmes data: 23 countries
  • empirical findings:
    • purely counter-cyclical explanation does not hold
    • long-term high rates of economic growth associated with contraction of informal economy or slower rate of growth of informal economy

Rosanna Galli and David Kucera 20032

  • definition of informality: employment in small firms (<10 workers) + self-employment + domestic work
  • number of countries: 14 Latin American countries
  • source and type of data: national labour force data compiled by ILO regional office – time-series (1990-1997)
  • empirical test of two causal theories: informalization as a) a buffer over business cycles + b) a response to labour regulations (notably, freedom of association, collective bargaining, and high wages)
  • empirical findings:
    • counter-cyclical aspects (survival and subordinate) + pro-cyclical aspects (independent and subordinate) of informality – compositional shift in the nature of informal employment over business cycles
    • limited absorptive capacity of informal sector + saturation during profound recessions
    • strong “civic rights” associated with relatively high shares of formal employment and low shares of informal employment

Norman V. Loayza and Jamele Rigolini 20063

  • proxy measure of informality: self-employment
  • number of countries: 18 developing + 24 developed (“high-income”)
  • source and type of data: national labour force surveys compiled by the ILO – time-series
  • causal theory: relative costs and benefits of informality and formality + distribution of workers’ skills determine size of informal economy
  • empirical findings: informality is counter-cyclical
    • long-term growth: informal economy is larger in countries with lower GDP per capita + higher costs of formality (rigid business regulations) + weak monitoring of informality (weak policy and judicial systems)
    • short-term business cycle: buffer that expands in economic recessions or adjustment mechanism during temporarily high tax regimes
    • variations in counter-cyclical response: lower in countries with high levels of a) informal employment or b) rule of law (police + judicial systems)

Summary Overview

# 1 – different countries demonstrate significant variation

  • sharp economic downturns are associated with an expansion of the informal economy
  • steady rates of economic growth in some countries are associated with an expansion of the informal economy
  • long-term high rates of economic growthin most countries associated with a contraction of the informal economy or slower rate of growth of informal economy

# 2 – different segments of the informal economy demonstrate substantial variation

  • certain segments of the informal economy expand during economic downturns:
    • survival activities
    • sub-contracted and outsourced activities – as firms cope with recession
  • certain segments of the informal economy expand during economic upturns:
    • dynamic independent enterprises
    • sub-contracted and outsourced activities – as production is restructured with trade liberalization

In its research, the WIEGO network has also found that there is no clear co-relation between growth in GDP and the share of informal employment in total employment:

  • Sub-contracted work or industrial outwork presents a mixed picture: it is associated both with low growth and economic downturns and with trade liberalization and global production.
  • Non-standard employment in highly industrialized countries also presents a mixed picture:it seems to be expanding in all industrialized countries at a rate that is not necessarily linked to the rate of economic growth.

1  Heintz, James and Robert Pollin. 2002. “Informalization, Economic Growth and the Challenge of Creating Viable Labor Standards in Developing Countries.”

2 Galli, Rosanna and David Kucera. 2003. “Informal Employment in Latin America: Movements Over Business Cycles and the Effects on Worker Rights”, Institute of International Labour Studies Discussion Paper, No. 145. Geneva: ILO. 

3 Loayza, Norman V., and Jamele Rigolini. 2006. “Informality Trends and Cycles.” Policy Research Working Paper 4078. Washington, D.C.: World Bank.