WIEGO: Women in Informal Employment Globalizing and Organizing

About the Informal Economy

Causes and Consequences

Causes –

There are different causal theories of what gives rise to informality. Many economists subscribe to the notion that informal entrepreneurs choose – or volunteer – to work informally (Maloney 2004). Yet many economists also recognize that informal employment tends to expand during economic crises or downturns, suggesting that necessity - in addition to choice - drives informality. Other observers point out that informalization of employment relations is a feature of contemporary economic growth and the global economy. A worker focus helps to deepen our understanding of what gives rise to informal employment under different circumstances, including the following:

Some of the self-employed choose – or volunteer – to work informally in order to avoid registration and taxation. While others do not choose to work informally but do so out of necessity or tradition.
Many of the self-employed would welcome efforts to reduce barriers to registration and related transaction costs especially if they were to receive the benefits of formalizing, such as written and enforceable commercial contracts as well as access to financial resources and market information.
Much of the recent rise in informal wage employment is due to the decline in formal employment or the informalisation of previously formal employment relationships.
Formal employment relationships get informalized when employers choose to a) retain a small core regular workforce and hire other workers on an informal basis; b) avoid payroll taxes and employer-contributions to social security or pensions; and/or c) avoid other obligations as employers. In such cases, the employers (not the workers) are avoiding regulation and taxation.

For an integrative causal model of the informal economy which includes informal employment by choice, informal employment by necessity, and informal employment by tradition, click here. This model is a excerpt from The Progress of the World's Women 2005: Women, Work and Poverty, which can be read in its entirety by clicking here.

Segmentation –

To understand the informal economy, it is important to recognize that it is multi-segmented. The main segments of informal employment, classified by employment status, are as follows:

employers: owner operators of informal enterprises who hire others;
employees: unprotected employees with a known employer: either an informal enterprise, a formal enterprise, a contracting agency or a household;
own account workers: owner operators of single-person units or family businesses or farms who do not hire others;
casual labourers: wage workers with no fixed employer who sell their labour on a daily or seasonal basis;
industrial outworkers: sub-contracted workers who produce from their homes or a small workshop;
paid contributing members of cooperatives or producer groups: and
unpaid contributing family workers: family workers who work in family businesses or farms without pay.

A set of national data analyses in five developing countries commissioned for a 2005 UNIFEM publication found that, with respect to non-agricultural informal employment, women are more likely than men to work as own-account workers, domestic workers, and unpaid contributing workers in family enterprises (Chen et al. 2005). In contrast, men are more likely to work as employers and wage workers (ibid.)

In the countries studied for the UNIFEM publication, men comprise the majority of informal agricultural workers, although exceptions exist. However, in many countries women still account for a large share of own-account agricultural workers and a majority of unpaid workers on family farms. Typically, few women are employed as informal agricultural wage workers. Informal agricultural employment tends to be more precarious than non-agricultural informal work, and it is characterized by very low earnings, uncertain incomes, and high risks of poverty.

Costs and Benefits -

The poverty and other outcomes of work are a function not only of the level of earnings but also of the period over which earnings are sustained and the arrangements through which they are achieved, including related costs and benefits. It is widely assumed that informal operators choose to do so because of the associated benefits. The most widely cited benefits of informal enterprises include tax avoidance, illegal occupation of premises, and illegal tapping of electricity, all of which are seen to lower the cots of informal enterprises and given them a competitive advantage over formal firms that pay taxes, rent and utility bills. However, a 2004 World Bank survey found that, compared to all size of formal firms (small, medium, and large), informal firms:

pay relatively high bribes (using bribe payments as a share of sales as the measure);
have less access to formal finance;
experience more frequent electricity outages;
find government services less efficient;
are more vulnerable to being evicted or shut down; and
are more likely to have to pay bribes or be harassed by officials (Hallward-Driemeier and Stone 2004).

But what about the relative costs and benefits of informal wage work? The cost-benefit debate tends to focus on the self-employed in the informal economy – and often on the more entrepreneurial among them. What is needed is an understanding of the specific costs and benefits associated with different categories of informal employment and different dimensions of informal employment - place of work, employment relationship, and system of production.

The WIEGO network has undertaken a number of research studies to help fill in this picture. In sum, while informal employment does offer positive opportunities and benefits, the benefits are often not sufficient and the costs are often too high for more of those who work informally to achieve an adequate standard of living. Some costs are direct in the form of ‘out of pocket’ expenses needed to run an informal business or work informally; others are indirect, reflecting the more general conditions under which the working poor live and work. For instance, many informal workers face significant occupational hazards (direct costs) yet are not covered by occupational health and safety regulatory or compensation mechanisms (indirect costs). Some of the hidden costs of informal employment can be rather high over the long-term, such as when a worker has to sacrifice access to health and education (or training) for herself or family members. For the “hidden costs” of informal employment, click here.

In addition, most informal workers have to forego the benefits associated with working formally and being legally recognized by the state. Formal enterprises are more likely than informal enterprises to have access to financial resources and market information; secure and enforceable commercial contracts; membership in business associations; and incentive packages, subsidies, or support services to promote competitiveness. Formal wage workers are more likely than informal wage workers to have unemployment funds; workers’ compensation and maternity benefits; health insurance and retirement savings; and collective bargaining agreements or dispute resolution mechanisms.

For more detailed discussions of the costs and benefits of informal employment, see Chapter 4 of UNIFEM’s Progress of the World’s Women 2005: Women, Work and Poverty and Part II of a recent monograph on SEWA’s Membership.

Links with Poverty -

The WIEGO network has also analyzed national data on the links between informality, poverty, and gender, including a summary overview of existing national data for the World Bank in 1999 (Charmes 2002); and new analyses of national data in six developing and one developed country for UNIFEM in 2005 (Chen et al. 2005). These analyses found a hierarchy of average earnings and segmentation by sex both between the formal and informal economies and within the informal economy. These findings can be summarized as follows:

There is a significant, but not complete overlap, between working informally and being poor. Average earnings are lower in the informal economy than in the formal economy.
However, one category of informal employment – i.e., informal employers who hire others – is associated with relatively high average earnings: higher than the average earnings of all other categories of informal employment and some low-end categories of formal wage employment.
Within the informal economy, average earnings are highest for informal employers followed by informal wage workers with a steady job and lowest for casual day labourers followed by industrial outworkers.
Within the informal economy, women are under-represented among employers or steady wage workers and over-represented among industrial outworkers.

For figurative illustrations of these findings, from UNIFEM’s 2005 Progress of the World’s Women, click here.

For a more detailed picture of the links between informality, poverty, and gender, see recent article in The Economic and Political Weekly by Chen, Vanek, and Heintz.

Links with Growth –

The linkages between informality and economic growth can be understood as operating in two directions as follows:

Contribution of informal economy to economic growth: what does the
informal economy contribute to economic growth?
Impact of economic growth on the informal economy: does the relative size
of informal employment expand or contract with economic growth?

Contribution of the Informal Sector to Gross Domestic Product (GDP): There are, as yet, no estimates of the contribution of the informal economy as a whole to GDP. However, there are estimates of the contribution of the informal sector to GDP. These estimates indicate that the contribution of informal enterprises (i.e., the informal sector) to non-agricultural GDP is significant: see Table 2.8 in 2002 ILO publication, Women and Men in the Informal Economy: A Statistical Picture. The average (unweighted) share of informal sector in non-agricultural GDP varies from a low of 27 per cent in Northern Africa, 29 percent for Latin America, and 31 percent for Asia to a high of 41 per cent for sub-Saharan Africa. However, there is wide variation among the countries reported both within and across regions – from 13 per cent in Mexico to 58 per cent in Ghana. This reflects not only differences in the actual contribution of the informal sector to GDP but also differences in the methods used among the countries in preparing these estimates: see Box on estimating informal sector contribution to GDP in 2002 ILO publication, Women and Men in the Informal Economy: A Statistical Picture.

Impact of Economic Growth on the Informal Economy: There is a long-standing assumption that the informal economy expands during economic slumps and shrinks during periods of economic growth: i.e., that the informal economy is counter-cyclical. However, this assumption pertains to the informal sector narrowly defined – not the informal economy broadly defined. Also, it is not always clear whether the evidence cited to prove this assumption pertains to employment in and/or output from the informal sector. A more recent assumption is that economic growth – or, more specifically, trade liberalization – is associated with an increase in informal jobs: in other words, that informal wage employment is pro-cyclical.

But what does the available evidence show? Recent evidence from 20 developing countries (analyzed by Heintz and Pollin 2002 ) and 14 Latin America countries (analyzed by Galli and Kucera 2003) suggests that countries demonstrate substantial variation in their patterns of informalization - as follows:

Counter-Cyclical Pattern:

sharp economic downturns are associated with a rise in informal employment
certain forms of informal employment expand during downturns in the economy – notably, survival activities as well as some sub-contracted or outsourced activities – as firms cope with recession

Pro-Cyclical Pattern:

increasing rates of informal employment are consistent with steady rates of economic growth
certain forms of informal employment expand during upturns in the economy – notably, independent self-employment as well as some sub-contracted or outsourced activities – as production is restructured with trade liberalization

What this mixed picture suggests is that certain forms of informal employment are features of modern capitalist development: most notably, outsourced production and sub-contracted jobs in global value chains.