Are Unfounded Assumptions About the Informal Economy Undermining Universal Social Protection?

While mainstream debates tend to view the informal economy as a residual component, we know that from an employment perspective it is actually the norm: 61 per cent of all working people in the world and 70 per cent of those working in middle- and low-income countries are in informal employment.

We social protection people sometimes speak of the ‘missing middle’ when talking about social protection coverage for informal workers. Calling in the ‘missing majority’ may be more appropriate. 

Informal workers are mostly excluded from social protection systems — with dire consequences during COVID-19.

Despite facing higher risks of poverty than their formally-employed peers, few informal workers have access to social protection. While often excluded either de jure or de facto from employment-linked social insurance, they also tend to fall outside of most narrowly poverty-targeted social assistance. 

As social protection responses to COVID-19 have largely piggy-backed on pre-pandemic systems, they have deepened inequalities between those with access to social protection and those without. Although unprecedented attempts were made to expand social protection to groups previously not covered, the majority of informal workers remained unprotected during the lockdowns of 2020.

Why is such slow progress being made in providing social protection to informal workers? 

It is fair to say that there are a number of legitimate and often complex challenges that governments face in expanding social protection to workers in the informal economy. These include legal, financial, administrative and institutional barriers. 

Yet, there are also plenty of examples from around the world, which prove that with some ingenuity, flexibility, and an ear to informal workers, these challenges can be overcome. For instance, in a number of middle-income countries, such as in South Africa, Argentina and Uruguay, progress has been made to include informal workers into social insurance systems.

If we have evidence that it can be done, what is holding us back? 

Influential assumptions about the informal economy as barriers to universal social protection 

Although the goal of universal social protection has gained support from most social protection stakeholders, key principles remain contested at both the level of global financial institutions and within the design and financing of schemes at national level. 

We, the social protection team at WIEGO, think that much of this contestation has its roots in assumptions about the informal economy, which result in powerful policy ideas counteracting efforts to achieve universal social protection. 

One of these ideas we call the ‘Perverse Incentive Thesis’ (PIT). This argument was most clearly outlined  in Santiago Levy’s 2008 book in which he argues that Mexico’s social protection system, which combines employment-linked social insurance with tax-financed social assistance for low-income informal workers, has incentivized informality. The reason is that social insurance schemes place a “tax” on formal employment, while informal work is “subsidized” through the provision of non-contributory benefits. This “traps” workers in informality, leading to lower productivity and development. 

More recently, this line of thinking featured notably in UNDP’s 2021 Regional Human Development Report for Latin America, which argues that social protection is central to firms and workers’ decisions to pursue formal and informal work. 

Firms react because it determines when they must pay for the social insurance of their workers and when not […].  Similarly, workers react because, depending on whether they work on their own or are employed by firms as dependent workers, they may or may not have to contribute for some benefits; they may or may not have access to benefits that neither they nor the firm employing them have to pay for  […].

This claim is also deployed in a 2021 report by the IMF, in which the authors warn that means-tested benefits “generate severe disincentive effects and often create poverty traps”.

These arguments should be read in the context of the World Bank’s push, outlined in the 2019 World Development Report, to “delink” social protection from employment, in part due to perceived labour market distortions created by social insurance. 

Why are these arguments a problem for informal workers?  

For a number of reasons, these arguments risk undermining universal social protection. 

In short, these arguments might make governments more hesitant to include subsidies when designing social insurance schemes for informal workers. We know that for many poor informal workers, particularly women who are segregated into the most insecure and low-paying forms of informal work, contributory schemes are unlikely to be accessible without any support. 

To better understand these arguments, and how to respond to them, WIEGO recently facilitated a discussion between academics, researchers and experts from the UN and bilateral agencies. 

Kicking things off, we were reminded that arguments framing social insurance contributions as a cost to employers can be used against any labour regulation. If social insurance contributions lead to employers preferring informal workers, then surely minimum wages or health and safety regulations create similar effects. Where does this lead us, other than a bonfire of worker protections? 

Participants also quickly pointed to a number of conceptual shortcomings. Proponents of these arguments present markets as essentially consisting of level playing fields without serious power imbalances, discrimination and segmentation, and no distortions other than social protection. 

However, instead of lamenting that social protection unduly impacts otherwise well-functioning markets, we should recognize that labour markets in particular are quite distorted to begin with and that social protection plays an important role in addressing some of these problems. By enhancing workers’ bargaining power and protecting them from harmful practices, social protection programmes and labour regulations can create better social and economic outcomes for everyone, but especially for workers more vulnerable to exploitation. 

It was also noted that the claim that social protection and informality cause lower growth lacks an empirical basis and runs counter to existing evidence on the productive impacts of social protection. Viewing social protection only as a cost ignores the significant social and macro-economic benefits of social protection. Moreover, the causality could run just as well in the other direction, that structural development challenges reduce formal employment opportunities. In any case, the relationship is surely more complex than such simple and monocausal answers. 

On a positive note, discussants acknowledged that these arguments rightly emphasize the importance of scheme and system design, and that the potential of unintended consequences needs to be carefully considered. It was also appreciated that the PIT recognizes the agency of informal workers, who are trying to make the best decisions for themselves and their families while navigating often complex and difficult environments. This recognition of agency only gets problematic when far too much emphasis is placed on workers’ 'decisions, with little regard to the constraints they face. This omission is particularly glaring with respect to the constraints experienced by many women in the informal economy. 

Challenging unfounded assumptions that undermine universal social protection  

With generous support from the Swedish International Development Cooperation Agency (Sida), WIEGO now has the opportunity to present a more accurate and nuanced picture of informal workers’ access to social protection, and challenge these and other unfounded assumptions that undermine universal social protection.

Photo: A street vendor at work in Mexico City, Mexico. Credit: César Parra