Links with Growth

How much and in what ways does the informal economy contribute to economic growth? Or does the informal economy account for low productivity and low growth? Does the size of the informal economy shrink during economic growth and expand during economic slumps or downturns? Is it, in other words, counter-cyclical or pro-cyclical?

Impact of the Informal Economy on Economic Growth

There is a widespread assumption that the informal economy has low productivity and, therefore, contributes to low growth in countries (Levy 2007).However, the informal economy does contribute to growth, especially in developing countries with large informal economies. But more work needs to be done to improve the concepts, measures, and methods for measuring the contribution of the informal economy.

Estimates from the mid-1990s of the contribution of informal enterprises to non-agricultural GDP in 26 countries in Africa, Asia, and Latin America ranged from 17 per cent in the Republic of Korea to 58 per cent in Ghana (ILO 2002). These estimates do not include the contribution of the informal workforce outside informal enterprises. Thus, adequately measuring the contribution of the informal economy will require better estimates of the contribution of informal enterprises as well as estimates of the contribution of informal workers outside informal enterprises: in formal firms, in global value chains, for households (i.e. domestic workers), in agriculture, and in secondary activities.

The table below provides estimates of the contribution of the informal sector to the trade sector in nine countries in the late 1990s.

Informal Sector and Trade:
Share of Employment and Value Added 

Source: Estimates by Jacques Charmes for ILO 2002 report on Decent Work and the Informal Economy

The National Institute of Statistics and Geography (INEGI) in Mexico has played a lead role in the development of official statistics on informal employment, including the contribution of the informal economy to GDP.  Each year since 2003 INEGI has generated estimates of the contribution of the informal workforce both inside and outside informal enterprises.  The most recent estimates, for 2017-18, show that the informal workforce (which represented 57% of employment) contributed nearly one quarter (23%) of the GDP of that country: with the contribution of informal workers inside the informal sector (i.e. informal enterprises) slightly lower (at 11.1%) than the contribution of informal workers outside the informal sector (11.7%) (Negrete).

To fully value the contribution of the informal economy also requires understanding and measuring the indirect contributions of the informal economy. After all, the informal economy provides low-cost labour, inputs, goods, and services to both formal and informal enterprises, and low-cost goods and services to the general public, especially poorer households. It also contributes to environmental preservation and sustainable development (see Urban Informal Workers & the Green Economy).

In sum, the contribution of the informal workforce, both direct and indirect, is quite high in certain sectors and countries. For more details on the Systems of National Accounts and the measurement of GDP more generally and the measurement of the GDP contribution of the informal economy more specifically, including in Mexico, see Development of Statistics on the Informal Economy and Statistical Concepts, Definitions and Methods. 

Finally, the issue of productivity is important both for countries and for individual workers and their families as it sets a limit on the living standards that they can expect. In many contexts, informal enterprises and workers are less productive than formal enterprises and workers. But there is a need to explore why this is so and what “productivity” and “productive growth” mean in the informal economy if we want to improve individual earnings, household incomes, and overall growth.

First, it is important to consider all factors of production, not just labour. Compared to formal workers and enterprises, informal workers and enterprises have fewer – or less valuable –  factors of production other than their own labour: such as capital, land and technology. Second, they also have less bargaining power to demand their share of value added. The value of their production is often captured by employers, intermediaries along the supply chain, and especially the lead firms at the top of the supply chain. Third, definitions and measures of productivity vary from sector to sector. And there are few direct measures of the productivity of the informal workforce; most analysts use proxies or assumptions (James Heintz, personal communication).

Determining the productivity of the informal economy requires rethinking definitions and measures of productivity. For example, what is the value of informal services, which dominate the non-agricultural informal economy in most countries? Consider the productivity of a street trader, who depends on how much she sells in a given period of time. This has little to do with her labour, capital, equipment, or technology. It has to do with market access, aggregate demand, purchasing power, and the intensity of competition. Measuring her “productivity” is qualitatively different from measuring the amount of cassava a farmer produces on his acre of land or the number of garments an industrial outworker produces at her home (James Heintz, personal communication).

For information on the economic contributions of specific groups of informal workers - construction workers, domestic workers, home-based workers, street vendors, and waste pickers, see Occupational Groups.

Impact of Economic Growth on the Informal Economy

There is a widespread assumption that the informal economy is counter-cyclical: that is, it expands during economic downturns and contracts during periods of economic growth. However, recent analyses of data over time from different developing countries suggest a more complex and dynamic picture, with substantial variation in patterns of informalization across countries.

Sharp economic downturns are associated with a rise in informal employment. But in some countries, steady rates of economic growth are associated with an increase in informal employment. Certain forms of informal employment expand during downturns in the economy – including both informal survival activities and sub-contracted and outsourced activities due to formal firms trying to cope with recession. Certain other forms of informal employment expand during upturns in the economy, such as entrepreneurial small firms and sub-contracted and outsourced activities linked to the global production system.

Developing Countries

Three pairs of economists recently analyzed the linkages between the rate of informality and the rate of growth at two points in time in different sets of countries: James Heintz and Robert Pollin (2003) in 20 developing countries; Rosanna Galli and David Kucera (2003) in 14 Latin American countries; and Norman Loayza and Jamele Rigolini (2006) in 18 developing and 24 developed (high-income) countries.

Heintz and Pollin found that most of the developing countries (14 out of 20) experienced growth in informalization; four experienced a decline; and two experienced little, if any, change. Informalization increased in three countries with respectable per capita growth rates (>2%) and declined in two countries with poor per capita growth rates (<1%). “These patterns suggest that informal employment has been increasing faster than formal employment, even in countries with strong rates of growth” (Heintz 2006:17). The authors concluded that “(h)igher rates of growth are generally associated with smaller increases in the rate of informalization. At very high levels of growth, informalization may decline” (Ibid:18; Heintz and Pollin 2003). But they also note that such cross-country comparisons do not include all types of informal employment: notably, available data often exclude own account production and informal wage employment, especially industrial outwork. High levels of growth driven by export production may be associated with increases in certain types of informal employment: notably, industrial outwork for global supply chains (see evidence from Tunisia).

Galli and Kucera found both counter-cyclical aspects (survival and subordinated activities) as well as pro-cyclical aspects (independent and subordinated activities) of informality. They highlight that there are compositional shifts in the nature of informality over business cycles. They also note that the informal economy has limited absorptive capacity and gets saturated during profound recessions. Loayza and Rigolini found that the informal economy serves as a buffer that expands in economic recessions and as an adjustment mechanism for enterprises during temporarily high tax regimes. In terms of longer-term trends, they found that the informal economy is larger in countries with lower GDP per capita, with high costs of formality (rigid business regulations), and weak monitoring of informality (weak policy and judicial systems). 

In sum, cyclical patterns cannot fully explain the rate of informalization: structural factors also play a role. When it comes to informal self-employment, there is a widespread notion that excessive bureaucracy and costly regulations are what drives informality. But economic liberalization is associated with fewer regulations, not more. So what contributes to structural informal self-employment? First, the markets in which the smallest informal enterprises compete are often not de-regulated in the first generation of economic reforms: they often remain either outside the reach or control of government (e.g. traditional street trading in many countries around the world) or under the control of government (e.g. minor forest products in India). Second, as noted earlier, people turn to self-employment in the informal economy when they lose a job (which happens under conditions of economic growth as well as economic decline or stagnation) or when they need to supplement their earnings. When it comes to informal wage employment, certain forms of sub-contracted and outsourced jobs are associated with the global production system and trade liberalization.

Developed Countries

Few labour statisticians, economists, and other observers in developed countries use the concepts of informal sector or informal employment: the more common concept is that of “non-standard” work. And the most common categories of non-standard work for which official data are available are: temporary agency work, direct hire fixed-term work, part-time and some forms of self-employment, mainly own account. Although not all part-time workers and temporary workers are informally employed, in the sense of being unprotected, many receive few (if any) employment-based benefits or protection.¹ Comparable data on other categories of employment that are even more likely to be informal in nature – namely, contract work, industrial outwork, and casual day labour – are not readily available in developed countries.

In North American, European Union, and other OECD countries, available evidence suggests that the workforce has become “flexibilized” or informalized. In these regions, statisticians and researchers use the concept “non-standard” work for the forms of work that are flexible or informalized. The term “non-standard work” as commonly used includes a) jobs that entail an employment arrangement that diverges from regular, year round, full-time employment with a single employer without secure contract; and b) self-employment with or without employees (Carré and Herranz 2002). The common categories of non-standard wage work are temporary work, fixed-term work, and part-time work. Increasingly, inter-firm sub-contracted work in the service sector (such as janitorial services and home care) and in the manufacturing sector (such as garment making and electronic assembly) is also included. However, data on the categories of non-standard work discussed below, which are very likely to be informal (that is, unprotected), are not readily available in developed countries: informal wage work for informal enterprises (employees of the self-employed), for households (domestic workers), or for no fixed employer (casual day labourers).

What follows is a brief summary of trends in three categories of non-standard work – part-time work, temporary work, and self-employment – in Europe (Carré 2006; Carré and Herranz 2002).

Part-Time Work – Since the early 1970s, there has been a marked growth in the proportion of part-time workers in total employment. By 1998, part-time workers accounted for 16 per cent of total employment in European Union (EU) countries and 14 per cent of total employment in Organization of Economic Cooperation and Development (OECD) countries.

Temporary Employment – For the EU as a whole, and in a majority of EU nations, the share of workers in temporary employment, including both direct hire and agency hire, increased from the mid-1980s to the late 1990s. By 1998, temporary employment accounted for around 10 per cent of total employment in EU countries.

Self-Employment – Self-employment, including both employers and own account workers, has increased in many OECD countries over the past 25 years.² Indeed, outside of agriculture, self-employment has grown at a faster rate than total employment in 14 (out of 24) OECD countries where data were available. Also, as self-employment has been growing, it is the share of own account self-employment within total self-employment that has grown more rapidly. As a result, in OECD countries today, more self-employed persons are own account workers, who are the most likely to be informal, than employers.

Informalization of Labour Markets by Sex

The last two decades have seen a marked increase in women’s labour force participation: most significantly in the Americas and Western Europe and more modestly in Sub-Saharan Africa, Southeast Asia, and East Asia (Heintz 2006; UNRISD 2005). Only in two regions – Eastern Europe and South Asia – has the women’s labour force participation rate actually fallen. The marked increase in women’s labour force participation worldwide has given rise to the notion of the “feminization of the labour force.” But this notion has been defined and used in two distinct ways. First, to refer to the situation in which the ratio of women’s labour force participation rate to men’s labour force participation rate increases over time. Second, to refer to a situation in which the structure of the labour force itself is “feminized” – that is, when jobs take on features associated with women’s work such as low pay, drudgery, uncertainty, and precariousness (Heintz 2006; Standing 1989, 1999).

Whether or not there is a causal link between the increase in women’s labour force participation and the growing precariousness or informality of work is not clear – and has been hotly debated. Are the expansion of women’s labour force participation and the informalization of labour markets over the past two decades linked in some way, or do they represent parallel but distinct processes? The pervasive segmentation of labour markets by gender, discussed below, suggests that women’s labour did not simply substitute for men’s labour. Rather, that there has been some parallel process at work creating low-paid and poor quality informal employment opportunities for (primarily) women (Heintz 2006; Standing 1989, 1999).

Estimates of changes over time in the degree of informalization within the female and male labour force are not available. However, a recent analysis of trends in the Tunisian labour market, with a special focus on informal employment, suggests the kind of analysis required and the trends that might be found elsewhere.

Understanding Variation: The Example of Tunisia

Between 1975 and 1997, informal employment in Tunisia grew very fast. During the economic slump of the 1980s, the share of informal employment increased: accounting for almost 40 per cent of non-agricultural employment by 1989. This trend confirmed the conventional notion that the informal economy expands during economic downturns. However, during the rapid economic growth and trade liberalization of the 1990s, the share of informal employment grew even faster: accounting for over 47 per cent of non-agricultural employment by 1997. In brief, while informal employment grew at an annual rate of over 5 per cent in the late 1970s and 1980s, it grew at an annual rate of 7.5 per cent between 1989 and 1997 (Charmes and Lakehal 2003).

How can this apparent contradiction be explained? The authors make the case, with supporting data, that the distinction between informal employment inside the informal sector (that is, unincorporated or un registered enterprises) and informal employment outside the informal sector is behind this seeming contradiction. During the late 1970s and 1980s, it was largely informal employment inside the informal sector that grew. However, during the economic growth of the 1990s, it was largely informal employment outside the informal sector that grew: notably, informalized and sub-contracted labour for larger enterprises, most of it undeclared. By 1997, less than half of the informal workforce (46%) was employed in small informal enterprises (that is, the informal sector) while over half (54%) was employed as undeclared informal workers for both formal and informal enterprises: most of these workers were women outworkers for export-oriented firms. In brief, the evidence from Tunisia suggests that while employment inside the informal sector may be counter-cyclical, informal employment outside the informal sector may be pro-cyclical (Charmes and Lakehal 2003).

The Tunisian example confirms what the cross-country analysis, summarized above, suggests: namely, that certain forms of informal employment – notably, sub-contracted work linked to the global production system – expand during periods of economic growth, especially when growth is driven by trade and financial liberalization. What is important to note is that women workers tend to be overrepresented in global production systems, at least in the early stages of industrialization and trade liberalization, when a premium is placed on export-oriented light manufacturing and low-skilled (and low-paid) workers (Chen et al. 2005).

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Notes:

¹ Part-time work is often not informal (that is, unprotected). In the Nordic countries, part-time work is often long-term with social protection. In the USA, however, part-time workers are offered few benefits: in the mid-1990s, less that 20 per cent of regular part-time workers had employer-sponsored health insurance or pensions (Hudson 1999). Return to text

²  Statisticians distinguish three main sub-categories of self-employment: 1) “employers,” the self-employed who hire others; 2) “own account workers” who do not hire others; and 3) “unpaid contributing family workers.” However, many statistical analyses, such as those by the OECD reported by Carré 2006, exclude unpaid family members because they are considered “assistants,” not “entrepreneurs.” Since the majority of unpaid family workers in most contexts are women, this exclusion understates the real level of women’s labour force participation and entrepreneurship (Carré 2006). Return to text