Policies & Programmes

Policy Debates

Causal Theories

Over the years, the debate on the informal economy has crystallized into four dominant schools of thought regarding the causes, composition, and nature of the informal economy, and what should be done about it.

  • The dualist school sees the informal sector as comprised of marginal and survivalist activities – distinct from and not related to the formal sector – that provide income for the poor and a safety net in times of crisis. According to this school, the persistence of informal activities, and thus a dualistic labour market, is due largely to the fact that not enough modern employment opportunities have been created to absorb surplus labour in developing countries, due to slow rates of economic growth and/or faster rates of population growth (ILO 1972).
  • The structuralist school sees informal enterprises and informal wage workers as subordinated to the interests of large capitalist firms, supplying cheap goods and services. According to the structuralists, in marked contrast to the dualists, formal and informal modes of production are inextricably connected and interdependent. Also, the nature of capitalist development (rather than a lack of growth) accounts for the persistence and growth of the informal economy (Castells and Portes 1989).
  • The legalist school sees the informal sector as comprised of informal entrepreneurs who choose to operate informally in order to avoid the costs, time and effort involved in formal registration. According to this school, cumbersome government rules and procedures create barriers to formalization and thus stifle the productive potential of informal entrepreneurs (de Soto 1989, 2000).
  • The voluntarism school also focuses on informal entrepreneurs who deliberately seek to avoid regulations and taxation but, unlike the legalist school, does not blame the cumbersome registration procedures. According to this school of thought, informal entrepreneurs choose to operate illegally – or even criminally – in order to enjoy the benefits of avoiding taxation, commercial regulations, electricity and rental fees, and other costs of operating formally (Maloney 2004).

In yet another approach, often focused on transitional and developed countries, the informal sector is seen as one in which the activities are illegal, hidden, or underground. For more details on these schools of thought on the informal economy, please see Informal Economy/History & Debates.

Policy Responses

Each school of thought focuses on a different segment of the informal economy – from survivalists to sub-contracted producers and workers to independent entrepreneurs. As a result, each school has distinct notions of what a policy response to the informal economy should entail, as follows:

  • The dualists argue that governments should create more jobs and provide credit and business development services to informal operators, as well as basic infrastructure and social services to their families.
  • The structuralists argue that governments should address the unequal relationship between “big business” and subordinated producers and workers by regulating both commercial and employment relationships.
  • The legalists argue that governments should introduce simplified bureaucratic procedures to encourage informal enterprises to register and extend legal property rights for the assets held by informal operators in order to unleash their productive potential and convert their assets into real capital.
  • The voluntarists focus on bringing informal enterprises under the formal regulatory environment in order to increase the tax base and reduce unfair competition by informal enterprises.

Given the heterogeneity of the informal economy, there is merit to each of these perspectives as each school reflects one or another “slice of the (informal) pie.” But the informal economy as a whole is more heterogeneous and complex than the sum of these perspectives would suggest. Therefore, an integrated policy framework that draws on all of these policy prescriptions to address different forms and aspects of informality is called for.

Formalization

At the heart of the current policy debates on the informal economy is the question of whether and how to formalize the informal economy. Different observers have different notions of what formalization should entail: registration, taxation, organization and representation, legal and social protection, business incentives and support, and more. It is important to understand what formalization might mean to different groups in the informal workforce. To date, the formalization debate has focused primarily on the self-employed in informal enterprises; and often, more specifically, on informal entrepreneurs who hire others. At a minimum, the formalization debate needs to distinguish between wage workers in informal jobs and self-employed in informal enterprises. Ideally, it should further distinguish between different segments of the self-employed and wage employed in the informal economy: as each segment has its particular needs and constraints (Chen 2006).

Secondly, it is important to ensure that formalization offers the benefits and protections that come with being formal and does not simply impose the costs of becoming formal. For the self-employed, formalization should not mean just obtaining a license, registering their accounts, and paying taxes: these represent, to them, the costs of entry into the formal economy. What they would like is to receive the benefits of operating formally in return for paying these costs, including: enforceable commercial contracts; legal ownership of their place of business and means of production; tax breaks and incentive packages to increase their competitiveness; membership in trade associations; protection against creditors and clear bankruptcy rules; and social protection.

What about informal wage workers? To them, formalization means obtaining a formal wage job – or formalizing their current job – with a secure contract, worker benefits, membership in a formal trade union, and employer contributions to their social protection. It is important to highlight that formalizing wage work requires a focus on employers: as employers are more likely than employees to avoid compliance with regulations. Also, it should be noted that many informal wage workers work for formal firms and households, not just for informal enterprises.

Clearly, no single, overarching policy goal or prescription can address the concerns associated with all categories of informal enterprises, activities, or workers. What follows in these web pages provides a framework of four broad policy goals to address informality. There is a growing consensus in development policy circles around these four broad goals, especially in support of the working poor who comprise the majority of the informal workforce. But there is limited consensus and on-going debate regarding how to implement the goals, including the role of the state and the formal economy.

Policy Framework

In development policy discourse on the informal economy, four broad policy goals are increasingly evoked: namely to …

  • create more jobs
  • formalize the informal economy
  • extend state protections to the informal workforce, especially the working poor
  • increase the productivity of informal enterprises and the income of informal workforce

But, as noted earlier, there is a good deal of disagreement on how to implement or operationalize these goals.

Goal # 1 – Create More Jobs, Preferably Decent Jobs

There is a broad consensus that more jobs need to be created – preferably decent or formal jobs – through labour-intensive growth. Some observers argue that this can be done through employment policies alone while others argue that employment goals need to be integrated into development strategies more generally. Some observers also argue that this should involve a transformation in the overall structure of employment opportunities and the ability of the working poor to take advantage of such opportunities as they become available. See Heintz 2004 on integrating employment goals into development strategies.

Goal # 2 – Formalize the Informal Economy

The terms of the formalization debate need to be reframed by highlighting that formalization has different dimensions: registration, taxation, organization and representation, legal and social protection, business incentives and support, and more. And that formalization has different meanings for different segments of the informal economy. It is also important to acknowledge that it is unlikely most informal producers and workers can be formalized – although efforts should be made to do so. For a framework for rethinking formalization, which includes what formalization might mean for specific groups of informal workers: see Rethinking Formalization: The WIEGO Perspective.

Goal # 3 – Extend State Protection to the Informal Workforce

In development policy circles, two types of state protection for the informal workforce – especially the working poor – are actively under consideration: social protection and legal rights.


Social Protection

Social protection is once again high on the development policy agenda, especially in the aftermath of the global economic crisis, which undermined the livelihoods of many working poor in the informal economy (Horn 2009, 2010). There is a growing consensus in development policy circles on the need to …

  • prioritize extension of social protection coverage to excluded groups
  • adapt both social and private insurance to incorporate informal workers by providing fiscal and other incentives for their affiliation
  • coordinate diverse forms of protection (social and private)

More specifically, there is a growing consensus around the need for universal pensions and health coverage. But there is little agreement on the appropriate role of government, the degree of government responsibility and public expenditure, the mix of private versus public insurance and provision.

Legal Protection

There is also a growing commitment in development policy circles to extending legal protection to the working poor in the informal economy. In its final report entitled Making the Law Work for All, the Commission for Legal Empowerment of the Poor prioritized three areas of legal rights and empowerment for the poor in general and the working poor in the informal economy in particular: property rights, labour rights, and business rights. The Commission argued that without property rights, the intrinsic economic power of the property belonging to the poor remains untapped (a la de Soto). Without labour rights, the working poor lack worker benefits and suffer unsafe working conditions. And, without legally recognized businesses, the working poor cannot access credit or markets, enforce contracts, or insure their businesses against bankruptcy. The Commission also highlighted that the poor need access to justice and, more generally, the rule of law: see Commission on the Legal Empowerment of the Poor.

For more details on social and legal protection for informal workers, see Social and Legal Protection for the Informal Workforce.

Goal # 4 – Increase Productivity of Informal Enterprises & Incomes of the Informal Workforce

There is a broad agreement that efforts should be made to increase the productivity of informal enterprises and the incomes of the informal workforce, especially the working poor. Standard approaches include: targeted measures such as financial services, enterprise support, and training; and general measures of state support, such as infrastructure services. The informal workforce needs productive assets, technical and business skills, and infrastructure services to better compete in the markets.

But increasing the productivity of informal enterprises and the incomes of the informal workforce also requires changes in the wider institutional environment, as follows:

Favourable Policy Environment - The economic policy environment needs to be supportive of informal operators, especially the working poor, rather than blind to them or biased against them. This requires addressing biases in existing economic policies, as well as designing and implementing targeted policies. This requires ensuring that macro policies create demand for the goods and services produced by informal enterprises and workers.

Improved Terms of Trade - To compete effectively in markets, the working poor need not only resources and skills but also the ability to negotiate favourable prices and wages for the goods and services they sell, relative to their cost of inputs and their cost of living.

Appropriate Legal Frameworks - As noted above, the working poor in the informal economy need new or expanded legal frameworks to protect their rights and entitlements as workers and as entrepreneurs, including the right to work (e.g., to vend in public spaces), labour rights, business or commercial rights, and property rights.

Protection against Risk and Uncertainty - The working poor need protection against the risks and uncertainties associated with their work, as well as against the common core contingencies of illness, disability, property loss, and death.

There are, in effect, two broad ways to increase the productivity of informal enterprises and the incomes of the working poor in the informal economy. The first is to “increase the positives”: through supportive measures to increase assets and market access, to provide legal identity and rights, and to raise productivity. The second is to “reduce the negatives”: through measures that not only reduce risks but also address market power imbalances and policy or institutional biases that work against informal enterprises and workers. This requires recognizing when and how market power imbalances and policy biases favour large formal enterprises over smaller informal enterprises, formal workers over informal workers, and men over women within each of these categories.

The National Commission for Enterprises in the Unorganised Sector (NCEUS) in India recommended measures to promote informal enterprises and to address the negative impacts of various policies and schemes: see National Commission for Enterprises in the Unorganised Sector (NCEUS). For other promising examples of an integrated package of support to informal enterprises, see:

For a budget analysis tool developed and tested by WIEGO, see Informal Economy Budget Analysis. Finally, for WIEGO’s approach to promoting fair and ethical trade, inclusive urban policies, and social protection for informal workers, see WIEGO’s Core Programmes.

Policy Lessons

The clearest and most compelling policy conclusion is that there is no single overarching policy intervention to address the concerns associated with the informal economy – a range of interventions need to be examined and implemented. Another key policy conclusion is that interventions need to be tailored and targeted to meet the specific constraints, needs and risks of different groups of informal workers: informal self-employed as well as informal wage workers; high end versus low end informal enterprises and workers; those who avoid regulations and those for whom existing laws and regulations are inappropriate or irrelevant.

The third broad policy conclusion – arguably as important as the first – is that all economic and social policies need to be reviewed in terms of their impact on the informal economy and its constituent parts. It should not be assumed, as it was by the World Bank and others in the mid-1990s, that economic policies cannot reach and do not impact the informal economy (World Bank WDR 1995). Most economic and social policies have an impact – direct or indirect – on the informal economy. The challenge is to monitor the impacts, both positive and negative, of different policies on different categories of the informal workforce and to address the negative impacts.

This requires recognizing and addressing the fact that the employment effects of economic growth work their way through markets, policies, and institutions (social, economic, and political) in different ways for formal and informal enterprises; for formal and informal workers; and for women and men within each of these categories.

Finally, to ensure policy responses are appropriate to the constraints, needs, and risks faced by informal workers, especially the working poor, they need visibility in official statistics and representative voice in rule-setting and policy-making processes. Current efforts to improve the measurement of informal employment and informal enterprises in official labour force and other economic statistics need to be strengthened and sustained. For more, see the Informal Economy/Statistics and WIEGO/Statistics Programme.

Most importantly, current efforts to strengthen organizations of informal workers and to promote the representation of these organizations in rule-setting and policy-making processes need to be strengthened and sustained. For more on this, see Informal Economy/Organizing & Organizations  and WIEGO/Organization & Representation Programme.

In conclusion, those who work on the informal economy are frequently asked “Do you seek to promote informality?” The goal is not to promote informality but to increase the earnings and reduce the risks of the working poor in the informal economy. Informal employment is a widespread feature of today’s global economy and, on average, informal workers have lower earnings and face higher risks than formal workers. As expressed by the International Labour Organization in its 2002 report entitled Decent Work and the Informal Economy, the goal is to reduce the “decent work deficits” of informal workers: as they tend to experience greater deficits, than formal workers, in the four dimensions of decent work: opportunities, rights, protection, and social dialogue (ILO 2002).