Informal Economy

The informal economy is a significant part of many economies worldwide, particularly in developing countries. It provides livelihoods for a large portion of the global population but also presents challenges related to worker rights, tax revenue, and economic development. Understanding the informal economy is crucial for effective policymaking and sustainable development strategies.

What is the Informal Economy?

The informal economy encompasses a wide range of economic activities that operate outside the formal regulatory framework. These activities are often characterized by a lack of legal protection for workers, absence of social security benefits, and the absence of formal contracts. It includes self-employment in micro and small enterprises, unregistered businesses, and various forms of informal labor. The International Labour Organization (ILO) defines it as all economic activities by workers and economic units that are – in law or in practice – not covered or insufficiently covered by formal arrangements.

The concept of the informal economy has evolved over time. Initially, it was often viewed as a marginal or residual sector, expected to shrink with economic development. However, it has proven to be a persistent and, in many cases, a growing part of the economy, particularly in developing countries. Some scholars argue that the informal economy is not separate from the formal economy but is deeply intertwined with it, often providing essential goods and services to formal businesses and households.

Key Characteristics

Lack of Formal Regulation

The absence of formal regulation is a defining characteristic of the informal economy. This means that businesses and workers operate without adhering to labor laws, tax regulations, and other legal requirements. For example, street vendors in many cities operate without licenses or permits, and their activities are not subject to taxation. This lack of regulation can lead to lower operating costs for businesses but also exposes workers to exploitation and unsafe working conditions.

Predominance of Small-Scale Operations

Informal economic activities are typically small-scale, often involving individual entrepreneurs or small family-run businesses. These enterprises often lack access to formal credit, technology, and training, which limits their growth potential. Examples include smallholder farmers selling their produce at local markets, artisans producing handicrafts in their homes, and independent taxi drivers operating without formal registration.

Vulnerable Employment

Workers in the informal economy often face precarious employment conditions, characterized by low wages, long hours, and a lack of job security. They typically do not have access to social security benefits such as health insurance, pensions, or unemployment benefits. According to the ILO, informality is a major constraint on decent work in developing countries. For instance, domestic workers in many countries are often employed informally, without contracts or legal protections, making them vulnerable to abuse and exploitation.

Limited Access to Resources and Markets

Informal businesses often face barriers to accessing resources such as credit, land, and technology. They may also have limited access to formal markets, relying instead on informal networks and local customers. This can hinder their ability to grow and compete with formal businesses. For example, small-scale construction firms in informal settlements may struggle to obtain financing for projects or to secure contracts with government agencies.

Contribution to Livelihoods and Economic Activity

Despite its challenges, the informal economy provides livelihoods for a significant portion of the global population, particularly in developing countries. It also contributes to economic activity by producing goods and services, generating income, and creating employment opportunities. The UNDP recognizes the informal economy as a critical source of resilience for vulnerable populations, especially in times of economic crisis. For example, in many African countries, informal traders play a vital role in distributing essential goods and services to remote communities.

Real-World Examples

• Street Vendors in India: Millions of street vendors in India operate informally, selling food, clothing, and other goods in urban areas. They provide affordable goods and services to low-income populations but often face harassment from local authorities and lack access to basic amenities.
• Artisanal Miners in Sub-Saharan Africa: Artisanal and small-scale mining (ASM) is a significant source of livelihoods in many African countries. These miners often operate informally, without licenses or environmental permits, and are exposed to hazardous working conditions.
• Mobile Money Agents in Kenya: The rapid growth of mobile money in Kenya has created new opportunities for informal employment. Mobile money agents operate as intermediaries, facilitating transactions for customers who do not have access to formal banking services.
• Waste Pickers in Brazil: Waste pickers in Brazil collect and recycle waste materials, providing a valuable service to society while earning a living. They often work in informal cooperatives and face challenges related to health, safety, and social recognition.

Challenges and Considerations

One of the main challenges associated with the informal economy is the lack of legal protection for workers. Informal workers are often excluded from labor laws and social security systems, making them vulnerable to exploitation and poverty. Another challenge is the loss of tax revenue for governments. Because informal businesses and workers do not pay taxes, governments have fewer resources to invest in public services such as education, healthcare, and infrastructure.

There are different perspectives on how to address the challenges of the informal economy. Some argue that the focus should be on formalizing the informal sector by simplifying regulations, reducing taxes, and providing incentives for businesses and workers to register. Others argue that the informal economy should be recognized and supported as a legitimate source of livelihoods, with policies aimed at improving working conditions, providing access to resources, and promoting social inclusion.

The debate also involves the role of technology and Digital Public Infrastructure (DPI). Some argue that DPI can facilitate the formalization process by providing digital identities, payment systems, and access to information and services. Others caution that DPI can also exacerbate inequalities and exclude vulnerable populations if not designed and implemented inclusively. For example, digital literacy and access to technology can be barriers for informal workers in accessing DPI-enabled services.