The informal economy
The informal economy (otherwise known as the underground or shadow economy) includes illicit economic activity that exists alongside a country's official economy; examples include black market transactions and undeclared work. People evade taxes and regulations by working in the informal economy or by employing people illegally. On the other hand, it can also be a powerful force for advancing institutional change and can boost the overall production of goods and services in an economy. During times of economic crisis, like the Covid-19 pandemic, the informal economy can also function as an economic buffer, enabling goods and services to be provided, so that people don't suffer from lack of essentials.
Policymakers should view illicit work as a signal of the need for better regulation, a fair and transparent tax system, and more efficient institutions, i.e. good governance.
Informal employment in emerging and transition economies Updated
Reducing informality requires better enforcement, more reasonable regulation, and economic growthFabián Slonimczyk, March 2022In developing and transition economies as much as half the labor force works in the informal sector (or “shadow economy”). Informal firms congest infrastructure and other public services but do not contribute the taxes needed to finance them. Informal workers are unprotected against such negative shocks as ill-health, but for certain groups there can be scarce opportunities to enter the formal sector meaning informal employment is the only feasible option. Reducing informality requires better enforcement, more reasonable regulation, and economic growth.MoreLess
Inequality and informality in transition and emerging countries Updated
A bidirectional relationship between informality and inequality exists; in transition and emerging countries, higher informality decreases inequalityRoberto Dell'Anno, April 2021Higher inequality reduces capital accumulation and increases the informal economy, which creates additional employment opportunities for low-skilled and deprived people. As a result, informal employment leads to beneficial effects on income distribution by providing sources of income for unemployed and marginalized workers. Despite this positive feedback, informality raises problems for public finances and biases official statistics, reducing the effectiveness of redistributive policies. Policymakers should consider the links between inequality and informality because badly designed informality-reducing policies may increase inequality.MoreLess
Self-employment and poverty in developing countries Updated
The right policies can help the self-employed to boost their earnings above the poverty level and earn more for the work they doGary S. Fields, March 2019A key way for the world’s poor to escape poverty is to earn more for their labor. Most of the world’s poor people are self-employed, but because there are few opportunities in most developing countries for them to earn enough to escape poverty, they are working hard but working poor. Two key policy planks in the fight against poverty should be: raising the returns to self-employment and creating more opportunities to move from self-employment into higher paying wage employment.MoreLess
Enforcement of labor regulations in developing countries
Enforcement improves legal compliance, but its impact on welfare is country specific and unclearLucas Ronconi, March 2019More than half of private sector employees in the developing world do not receive legally mandated labor benefits. These regulations have typically been enacted by democratically elected governments, and are valued by both formal and informal workers. Increasing public enforcement (e.g. inspections, fines, and workers’ access to the judiciary) can be a powerful tool to reduce violations (e.g. increase the number of employees earning above the minimum wage). Which factors determine enforcement, and whether enforcement produces more social benefits than costs, are, however, unanswered questions.MoreLess
Does increasing the minimum wage reduce poverty in developing countries? Updated
Whether raising minimum wages reduces—or increases—poverty depends on the characteristics of the labor marketT. H. Gindling, November 2018Raising the minimum wage in developing countries could increase or decrease poverty, depending on labor market characteristics. Minimum wages target formal sector workers—a minority in most developing countries—many of whom do not live in poor households. Whether raising minimum wages reduces poverty depends not only on whether formal sector workers lose jobs as a result, but also on whether low-wage workers live in poor households, how widely minimum wages are enforced, how minimum wages affect informal workers, and whether social safety nets are in place.MoreLess
The shadow economy in industrial countries Updated
Reducing the size of the shadow economy requires reducing its attractiveness while improving official institutionsDominik H. Enste, November 2018The shadow (underground) economy plays a major role in many countries. People evade taxes and regulations by working in the shadow economy or by employing people illegally. On the one hand, this unregulated economic activity can result in reduced tax revenue and public goods and services, lower tax morale and less tax compliance, higher control costs, and lower economic growth rates. But on the other hand, the shadow economy can be a powerful force for advancing institutional change and can boost the overall production of goods and services in the economy. The shadow economy has implications that extend beyond the economy to the political order.MoreLess