Informal Economy

by

Bipasha Baruah

• LAST REVIEWED: 26 February 2013
• LAST MODIFIED: 26 February 2013
• DOI: 10.1093/obo/9780199874002-0051

Introduction

The terms “informal economy” and “informal sector” first appeared in academic literature and in policy circles in the 1970s. Keith Hart, an anthropologist working in Ghana, is most often credited with research on the informal sector during this time. Hart defined the informal sector as employment beyond government service, factories, and large-scale commercial ventures. He went on to classify informal employment in “legitimate” and “illegitimate” activities. He defined legitimate activities as those that made a contribution to economic growth at a small scale, for example, through home-based production, manual labor, or personal services. Hart conceptualized illegitimate informal activities as those that were not necessarily criminal in nature but were of questionable value to national development, such as begging, pickpocketing, scavenging, and streetwalking. Perhaps because there was so little research on the informal sector at that time, Hart’s work received a significant amount of attention within academic circles, labor organizations, and research institutions. The International Labour Organization (ILO), for example, used Hart’s work to distinguish between formal and informal employment based on criteria such as relative ease of entry, size, nature of enterprise ownership, type of production, and levels of skill, capital, and technology. Research on the nature, characteristics, size, and composition of the informal economy has grown dramatically in the past four decades, and many of Hart’s generalizations have long been challenged, if not outright rejected. Hart’s most enduring contribution to the most commonly used contemporary definition of the informal economy is that it lacks regulation by the political and economic institutions of a society. Other researchers have further fleshed out this defining criterion by pointing out that although regulation typically implies legality, it is important to recognize that the concept of legality itself has three dimensions that speak most directly to the difference between the formal and informal economic activities: legal recognition as a business activity, which involves registration, and possible subjection to health and security inspections; legality concerning payment of formal taxes and tariffs; and legality vis-à-vis labor matters, such as compliance with official guidelines on working hours, social security contributions, and fringe benefits. Many enterprises may only comply with one or two of these dimensions, so some researchers argue that the concepts of formality and informality may be better understood as a continuum rather than as a binary of watertight and mutually exclusive categories. As an example, a legally registered small business may not pay any social security benefits to its employees while a large corporation may use unrecorded cash payments on a regular basis as a way of avoiding or reducing taxation.

General Overviews

The absence of institutional regulation in the informal economy, as discussed by Hart 1973, affects various elements of the work process. First, it influences the status of labor, which may be undocumented, working below minimum wage, lacking social benefits, or employed under circumstances that legal or societal norms would not otherwise allow. Second, it influences the conditions of work under which labor is employed, which may involve ignoring health, hygiene, and other safety requirements. Third, it refers to a particular form of institutional management. For instance, a large company may engage in systematic fiscal fraud as a means of economic transaction. Some scholars of the informal economy (e.g., Tokman 1991) emphasize that there is no theoretical reason to exclude the unrecorded practices of large corporations from the informal economy since they are closely linked with the growth of other informal activities. The assumption that the informal sector is comprised only of precarious, low-skilled, poorly remunerated work in the urban areas of developing countries has been challenged with growing evidence of the sector’s heterogeneity from many parts of the Global North and South. Research conducted by Latin American scholars, for example, has emphasized the existence of an informal economy in all countries by including case studies ranging from New York City and Madrid to Uruguay and Colombia. This perspective reinforces that the informal economy is not a marginal phenomenon but a fundamental politico-economic process at the core of many developing and developed countries. The basic distinction between formal and informal economic activities does not hinge on the character of the final product but on the manner in which it is produced and exchanged. Articles of clothing, restaurant food, meat, fruits, and vegetables, for example, are not illicit commodities, but they may have their origins in legally regulated or unregulated production arrangements. Whereas academic debates about the informal sector have become more complex and nuanced over the years as a result of empirical research in different world regional settings, policy and practitioner engagement with the informal sector has remained quite simplistic, as evidenced by the International Labour Organization’s (ILO’s) continued deployment of policies based on evidence gathered about the informal sector in the early 1970s (see International Labour Organization 1972).

• Hart, K. “Informal Income Opportunities and Urban Employment in Ghana.” In Third World Employment-Problems and Strategy: Selected Readings. Edited by R. Jolly, E. de Kadt, H. Singer, and F. Wilson, 66–70. Harmondsworth, UK: Penguin, 1973.

  One of the earliest pieces of academic literature on the urban informal sector.

• International Labour Organization. Employment, Incomes and Inequality: A Strategy for Increasing Productive Employment in Kenya. Geneva, Switzerland: International Labour Organization, 1972.

  An example of the application of Keith Hart’s definitions of the informal sector in labor policy.

• Portes, A., M. Castells, and L. A. Benton, eds. The Informal Economy: Studies in Advanced and Less Developed Countries. Baltimore: Johns Hopkins University Press, 1989.

  The case studies in this book illustrate the existence of the informal sector in developed and developing countries.

• Tokman, V. “The Informal Sector in Latin America: From Underground to Legality.” In Towards Social Adjustment: Labour Market Issues in Structural Adjustment. Edited by G. Standing and V. Tokman, 141–157. Geneva, Switzerland: International Labour Organization, 1991.

  Identifies more complicated and nuanced features of informal sector economic activities.