World Bank: A Holistic Framework

In 2007, the Latin America division of the World Bank brought out a publication entitled Informality: Exit and Exclusion co-authored by Guillermo Perry, William F. Maloney, Omar Arias, Pablo Fajnzylber, and Jaime Saavedra. In this publication, the co-authors presented a holistic framework of the composition and causes of informality, as follows:

Composition: “Three Pairs” of Economic Agents

• Labour:
  • insufficient human capital to get formal job
  • quit formal job in order to: be their own boss + make more money + avoid taxes + enjoy flexibility
• Micro-firms:
  • no intention or potential for growth, hence no intention of engaging with state
  • stymied by high barriers to entry
• Firms:
  • avoiding taxation and other regulations
  • partially registering their workers and sales

Causal Theory # 1: Different Forms of Exit

• Opportunistic evasion
  • tax-evasion
  • illegal activities
  • avoidance of labour codes:
    • unprotected workforce
    • subcontracted production
• Defensive evasion in response to…
  • burdensome state
  • captured state
  • weak state
• Passive evasion and state irrelevance
  • pre-modern or bazaar economy
  • informal or non-state institutions

Causal Theory # 2: Different Forms of Exclusion

• Labour market segmentation - prevents workers from getting formal jobs
• Burdensome entry regulations – prevents enterprises from formalizing (a la de Soto)
• Hiring practices of firms - in response to excessive tax and regulatory burdens