World Bank: A Holistic Framework

In 2007, the Latin America division of the World Bank brought out a publication entitled Informality: Exit and Exclusion co-authored by Guillermo Perry, William F. Maloney, Omar Arias, Pablo Fajnzylber, and Jaime Saavedra. In this publication, the co-authors presented a holistic framework of the composition and causes of informality, as follows:

Composition: “Three Pairs” of Economic Agents

  • Labour:
    • insufficient human capital to get formal job
    • quit formal job in order to: be their own boss + make more money + avoid taxes + enjoy flexibility
  • Micro-firms:
    • no intention or potential for growth, hence no intention of engaging with state
    • stymied by high barriers to entry
  • Firms:
    • avoiding taxation and other regulations
    • partially registering their workers and sales

Causal Theory # 1: Different Forms of Exit

  • Opportunistic evasion
    • tax-evasion
    • illegal activities
    • avoidance of labour codes:
      • unprotected workforce
      • subcontracted production
  • Defensive evasion in response to…
    • burdensome state
    • captured state
    • weak state
  • Passive evasion and state irrelevance
    • pre-modern or bazaar economy
    • informal or non-state institutions

Causal Theory # 2: Different Forms of Exclusion

  • Labour market segmentation - prevents workers from getting formal jobs
  • Burdensome entry regulations – prevents enterprises from formalizing (a la de Soto)
  • Hiring practices of firms - in response to excessive tax and regulatory burdens
Informal Economy Topic