Informal Economy

The term informal economy refer to every kind of training that happens "off the books." The jobs people work, the businesses that employ them, the goods and services they produce are not accounted for in official records and data— such economic activity is untaxed and unregulated. Large informal economies exist in developed and developing countries alike. Often, informal economies arise because they meet the needs that their formal counterparts cannot.

Keywords Formal Economy; Gross National Product (GNP); Kinship Bonds; Non-Market Exchange; Post-Fordism; Reciprocity; Self-Provisioning; Social Marginalization; Social Network; Structural Unemployment; Subcontracting; Tax Morale; Transfer Payments; Transaction Costs

Informal Economy

Overview

It has many names: the black market, the underground economy, the shadow economy. In size and earning power, the "informal" economy generates an estimated $10 trillion dollars annually. Huge amounts of money change hands clandestinely every day in developing, transitioning, and industrialized countries alike As anyone who has ever worked "off the books" knows, taxes are not paid on unreported. In addition, trillions of dollars exchanged in the illegal trade of drugs, weapons, and other goods is also untaxed.

The nexus of laws, law enforcement, and the social norms and values collectively known as "tax morale" varies considerably from country to country. And the more widely a government is perceived to be indifferent to, or incapable of, bettering the lives of its people, the lower the tax morale. The lists of grievances against many governments are long: overregulation, poorly conceived fiscal monetary and trade policies, corruption, and the systematic rollback of government benefit programs. All these grievances have the potential make the average citizen's life worse not better. He or she, then, may feel justified following the path of least resistance to the underground economy. At least in this position, it is still possible to eke out a subsistence living or earn a little extra.

In either case, the argument can be made that an informal economy rights some of the wrongs of the formal economy. Indeed, pioneering studies in Africa and Latin America in the 1970s and 1980s found that a vigorous entrepreneurship was notability absent in these economies-at-large. This may be so, considering the ease of market entry, the flexible staffing practices, the low-end wage structure, and the minimal transaction costs made possible by forgoing taxes, benefits, license fees and the investments necessary to meet workplace health and safety regulations. What is good for the underground entrepreneur, however, is not necessarily good for his or her employees. With no real job security or assured working hours, no health or retirement benefits, and for what is rarely more than a subsistence wage, the underground employee is expected to work long hours in often unsafe or unhealthy environments. Powerless and often desperately poor, he or she, critics charge, fast becomes just another exploited worker (Mollona, n.d.).

The problem, of course, is that the formal economy simply does not have enough jobs to go around. This situation has been made worse in industrialized countries by shrinking social-safety nets and in other countries by the absence of such programs all together. Simply put, the so-called "welfare" state is now considered too expensive to maintain much less expand. Tax revenues once earmarked for transfer payments and public sector services, the theory goes, are now better left to the citizenry to spend or invest in order to stimulate economic growth. In developing nations, the new economic credo simply re-enforces the existing goal of first developing the free-market private sector until a tax base large enough to afford major public spending on human services materializes. However, critics of this theory often point out that, once the tax base does develop, much of this newly generated wealth still ends up in the bank accounts of developing countries' elites, not welfare programs.

Further Insights

The Formal Economy vs. The Informal Economy

Since both the informal and formal economies function as full-fledged markets and both generate revenue and income, what differentiates the two? The only universally accepted distinction lies in the fact that governments know about and tax the one but not the other. All the other distinctions scholars make are subject to debate. Some experts, for example, believe petty and organized crime are part the informal economy. Others think black-and-white answers are too simplistic: what is "purchased" and how it is paid for, they caution, can determine whether the transaction is legal, quasi-legal or illegal. Complicating matters further, opinions vary on the related question of whether or not non-market exchanges of favors among members of a social network should be evaluated the same as unreported monetary or commodity (barter) exchanges. If they are, scholars wonder whether regular housework done by a family member should also be counted. (Henry, n.d.).

One of the first major researchers in the field, Alejandro Portes, defined the baseline difference between the two this way: in the formal economy, employment is predicated on a legally-binding contract that spells out the rights and responsibilities of all concerned whereas in the informal economy, it is not (Øyen, 2006). An omnibus model proposed in 1990 by P. H. Renooy drew a series of finer distinctions, most notably how the informal economy has lower barriers to entry, capital requirements, productivity, and prices. It is, however, far more flexible in its use of labor, so much so that its workers often must juggle several "invisible" jobs to make ends meet. Most of these jobs are secured through referrals from family and friends. Entrepreneurs face difficulties, too; they must overcome the localized, fragmented nature of the "black" market in order to expand their business. Information about pricing, competitors, new products, and trends in consumer demand are also far more blemished than they usually are in above-board marketplaces (Gërxhani, 2004).

No wonder, then, that few underground businesses successfully transition into the formal economy. This is not to say, however, that the two sectors never overlap. If anything, the dominant business model in this era of Post-Fordism has only served to blur the boundary-lines between them. Companies, in effect, no longer aspire to be the vertically integrated manufacturer of old. The surer route to profitability these days lies in being organizationally lean, turning out more targeted goods, and concentrating on core competencies to the exclusion of everything else (Roberts, n.d.).

Nimbler responses to changing market conditions are this era's mantra, and outsourcing its preferred way of doing business. All of this has been a boon to cost-conscious subcontractors who pay far less, offer no benefits, and hire temporary help on an as needed basis only. Conversely, it has also been a blow to unskilled and semi-skilled workers in industrial countries as their well-paid factory jobs have been moved offshore. Globalization in this respect is Post-Fordism writ large. To survive competitively, manufacturing companies must chase the lowest unit cost absolutely anywhere that takes them. (Fulcher & Scott, 2003).

Acting as extra-legal intermediaries, subcontractors facilitate the free-flow of commerce between the formal and informal economies. They do this by relieving clients of the administrative and regulatory burdens of maintaining a permanent workforce, and by delivering finished goods or services at very competitive prices in amounts and frequencies set by clients for lump-sum payments. Subcontractors can do all this because, as smaller businesses, the regulatory demands placed upon them are typically less stringent and their enforcement laxer. Labor unions, moreover, generally do not organize workers at smaller companies, so subcontractors are not bound by industry wage standards. This, along with their eligibility for a relatively generous set of tax deductions, allows them to turn a profit (Leonard, 2000).

And the very fact that they've become so effective a conduit speaks volumes about how the two sectors are not the mutually-exclusive domains originally thought. More than 50 years ago, researchers studying emerging economies lumped together all urban, industrialized market activity in the "formal" sector, and all rural, subsistence agricultural activity in the "informal" sector. By the early 1970s, though, they began to notice how much of the manufacturing and commercial activity developing in third world cities went unregulated and untaxed. Within a decade, moreover, researchers had ample evidence that active informal economies also operated in advanced industrialized nations. A major reconsideration, not only of what differentiated the formal and informal sectors but also the extent of the two's interdependence, was clearly in order along with a closer examination of the ways a developed county's informal economy might differ from that of an underdeveloped country.

According to one new theory, the developed world's larger size, reach, output, and capitalization all but ordain the formal economy's domination. The only question is whether the larger economies have a pro-cyclical or counter-cyclical effect on the smaller. A recession, of course, counter-cyclically swells the ranks of the unemployed looking for work on or off the books. Yet high inflation also tempts legally employed workers to supplement their shrinking real incomes with off the books work. In prosperous times, increased demand for goods and services pro-cyclically stimulate growth and employment in both sectors. Meanwhile, signature counter-cyclical conditions - mass unemployment, stagnant economic growth, periodic bouts of high inflation - typify developing and less developed economies. Here, however, growth in the informal sector is stymied because, in the absence of legal safeguards, any large investment is considered too risky.

What also hadn't changed yet was the underlying theoretical assumption that most people in the informal economy were victims of or candidates for social marginalization. Be they illegal immigrants, welfare cheats, or the illiterate poor, it was assumed that their sole concern was survival. Later, critics rejected the dismissive inferences this notion raised. Operating largely by its own, they countered that the informal economy is actually an autonomous yet integral part of the national economy, and it can compliment it in important ways. Crucially, then, it is not just a refuge of last resort harboring society's outcasts, but rather a dynamic marketplace, albeit one with limited growth potential. (Gërxhani, 2004).

The Size of the Informal Economy

By definition, the sales and income generated by the informal economy are not recorded; thus, economists and statisticians can only hazard an educated guess at its real size. In a 2002 study, economist Friedrich Schneider estimated the relative size of informal economies worldwide. The figures were striking. In Georgia, Bolivia, Panama, Azerbaijan, Peru, Zimbabwe, Tanzania, and Nigeria, the overall size of the informal economy is greater than half of each country’s formal GDP. In the United States and Japan, the approximate value of informal trading exceeded $1 trillion annually.

Western Europe is also home to sizable subterranean economies: as much as the equivalent of 27% of the reported GNP in Italy; between 20% and 24% in Spain, Portugal and Belgium; and between 18% and 20% in Scandinavia. Significantly, the larger, more prosperous economies of France, Germany and Great Britain had fairly sizeable informal sectors of between 13% and 16% of their respective GNPs.

A whole stratum of the informal economy, however, is so invisible, even the most ingenious of economists have trouble gauging its size (and for good reason, since cash hardly ever changes hands). Forms of what economists call non-market exchange - self-provisioning, household production, swapping favors, etc. - are all but transparent except to those directly involved. Often, the product or service not has only intrinsic and economic value, but also value as a symbol of a social obligation to equitably share available resources. Sociologists call this process reciprocity. More widely practiced in low income neighborhoods than elsewhere, it is as much an assurance that help is available when needed as it is an alternate means of securing goods and services. However, this is providing that one gives as well as takes: reciprocity, remember, is above all an economic transaction. Anyone who cannot meet this basic condition-the aged and the disabled in particular-usually must rely instead on family, private organizations, and the state (Short, 1996).

Issues

Will the Informal Economy Last?

The informal economy has been likened to running water: it easily flows over or around whatever obstructions are in its way. As long as there are structural unemployment and social marginalization on the one hand, and limited opportunities in the formal economy on the other, job seekers will gravitate to the underground economy. Moreover, no economy stands still: new technologies and fundamental shifts in underlying consumer demand continually make traditional occupations obsolete and new ones promising. Additionally, there will no doubt always be periodic recessions and, more challenging still, a world population growing faster than the global economy. But people from all walks-of-life flock to the informal economy, not just the poor and disenfranchised, for reasons that have nothing to do with money. Be it for greater professional fulfillment, a more autonomous work environment, or a desire to help family and friends, people turn to the informal economy because of the greater freedom and promise they see there.

In all likelihood, then, there will always be an informal economy; it serves too many needs that would otherwise go unfulfilled. Of course, in theory, a national economy at full employment could eliminate the informal one. But would it really? In an informal economy, money is only one of several means of exchange and not always the most important. Kinship bonds and communal ties can and often do take precedence over purely pecuniary interests. We may all be economic actors, but we are all also social beings. Additionally, some people may find the informal economy to be more financially rewarding, since it allows them to evade taxes.

Tax Morale

A lax tax morale, however, is also a symptom of political discontent. People with a low tax morale are, in effect, frustrated and alienated to the point of opting out of the "system." More troubling still, government indifference, incompetence, and inefficiency oftentimes lets them. As a nation's tax base erodes, so does its government's authority and credibility. Worse, the government must raise taxes to meet the growing short-fall, motivating yet more of its citizens to defect to the informal economy. Ironically, though, too severe a crackdown on tax evasion can force an issue governments are very reluctant to broach. Cut-backs in transfer payments and public sector spending over the last twenty years have whittled them so far down they fall well short of paying for basic needs. Beneficiaries have to work "off the books" or seek the financial aid of families and friends just to survive. But prevailing political ideologies preclude a return to the welfare state, ample enough reason for most governments to tolerate an informal economy provided it doesn't grow too large.

All told, more is probably gained than is lost by having an informal economy. Why else, after all, would it exist? More to the point, what draconian measures would have to be introduced to stamp it out? Yes, it's illegal and often exploitive, but it also meets needs the formal economy cannot or will not address.

Terms & Concepts

Formal Economy: The sum total of taxable business activity conducted openly and legally.

Gross National Product (GNP): The total value of the goods and services made or tendered during a specified period, usually a year, minus the income earned by foreign investors from this, plus the income citizens earned from investments abroad.

Kinship Bonds: Affinity-based favoritism afforded members of a family afford to each other.

Non-Market Exchange: Usually, a bilateral in kind arrangement between family members, neighbors, or friends to provide each other with needed services. Does not, however, extend to the barter of goods, which is considered a commodity-exchange.

Post-Fordism: A model of industrial manufacturing that emphasizes just-in-time delivery, small-batch production-runs, the flexible use of part-time labor, and subcontracting occasioned by the decreasing profitability of mass-producing standardized consumer-goods.

Reciprocity: The mutual obligation to give and to receive. The product or service exchanged in a reciprocal relationship symbolizes the underlying social relationship and has value over and above the product’s or service’s material worth.

Self-Provisioning: Augmenting one's earnings via foraging, growing one's own food, or other non-cash-generating activities.

Social Marginalization: The exclusion of individuals or groups seen as outsiders from mainstream life.

Social Network: The informal associations shared by people brought together by family, neighborhood, work, or common interests or values. The term was coined in the 1950s by J. A. Barnes.

Structural Unemployment: Prolonged unemployment caused by underlying shifts in market supply and demand.

Subcontracting: The practice of assigning work to a third-party business as opposed to keeping it within the company originally hired to perform the work.

Tax Morale: Prevailing attitudes and values about paying taxes owed in full.

Transfer Payments: Cash subsidies and free services funded by the government out of tax revenues to aid the unemployed, indigent, and infirm.

Transaction Costs: Expenses related to researching different suppliers' prices, successfully bargaining a purchase, and then drawing up and enforcing a legal contract.

Bibliography

Berrou, J., & Combarnous, F. (2012). The Personal Networks of Entrepreneurs in an Informal African Urban Economy: Does the ‘Strength of Ties’ Matter?. Review Of Social Economy, 70, 1-30. doi:10.1080/00346764.2011.577347 Retrieved October 29, 2013 from EBSCO online database SocINDEX with Full Text:http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=73324637&site=ehost-live

Bonner, C., & Spooner, D. (2011). Organizing Labor in the Informal Economy: Institutional Forms & Relationships. Labour, Capital & Society, 44, 126-152. Retrieved October 29, 2013 from EBSCO online database SocINDEX with Full Text:http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=77895468&site=ehost-live

Fischer, G. (2013). Revisiting Abandoned Ground: Tanzanian Trade Unions’ Engagement with Informal Workers. Labor Studies Journal, 38, 139-160. doi:10.1177/0160449X13494846 Retrieved October 29, 2013 from EBSCO online database SocINDEX with Full Text: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=89066647&site=ehost-live

Fulcher, J. & Scott, J. (2003). Work, employment, and leisure: The transformation of work, employment, and leisure. In Sociology (pp. 612-637). Oxford: Oxford University Press.

Gërxhani, K. (2004). The informal sector in developed and less developed countries: A literature survey. Public Choice, 120 , 267-300.

Henry, S. (n.d.). The working unemployed: Perspectives on the informal economy and unemployment. Sociological Review, 30 , 460-477.

Kabeer, N., Milward, K., & Sudarshan, R. (2013). Organising women workers in the informal economy. Gender & Development, 21, 249-263. doi:10.1080/13552074.2013.802145 Retrieved October 29, 2013 from EBSCO online database SocINDEX with Full Text: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=89026462&site=ehost-live

Leonard, M. (2000). Coping strategies in developed and developing societies: The workings of the informal economy. Journal of International Development, 12 , 1069-1085.

Mollona, M. (n.d.). Factory, family and neighbourhood: The political economy of informal labour in Sheffield. Journal of the Royal Anthropological Institute, 11 , 527-548.

Øyen, E. (2006). Informal sector of the economy. In Poverty: An International Glossary . Retrieved May 13, 2008 from EBSCO online databse SocINDEX with Full Text: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=31487157&site=ehost-live

Roberts, B. (n.d.). Informal economy and family strategies. International journal of urban and regional research, 18 , 6-23.

Schneider, F., & Enste, D. (2000). Shadow economies: Size, causes, and consequences. Journal of Economic Literature, 38 , 77.

Short, P. (1996). Kinship, reciprocity, and vulnerability: Social relations in the informal economy. Australian Journal of Social Issues, 31 , 127-145. Retrieved May 13, 2008 from EBSCO online database SocINDEX with Full Text: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=9608010443&site=ehost-live

Valodia, I. (2013). Bringing the informal economy into the National Development Plan. Social Dynamics, 39, 115-118. doi:10.1080/02533952.2013.777559 Retrieved October 29, 2013 from EBSCO online database SocINDEX with Full Text: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=87044666&site=ehost-live

Suggested Reading

Harriss-White, B. (n.d.). Inequality at work in the informal economy: Key issues and illustrations. International Labour Review, 142 , 459-469. Retrieved May 13, 2008 from EBSCO online database SocINDEX with Full Text: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=13860549&site=ehost-live

Snyder, K A.. (2003). Working "off the books": Patterns of informal market participation within New York's East Village. Sociological Inquiry, 73 , 284-308. Retrieved May 13, 2008 from EBSCO online database SocINDEX with Full Text: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=9667584&site=ehost-live

Titov, V. (2003). Informal economy: Sociopsychological aspects. Social Sciences, 34 , 48-59. Retrieved May 13, 2008 from EBSCO online database International Bibliography of the Social Sciences: http://search.ebscohost.com/login.aspx?direct=true&db=sih&AN=10408253&site=ehost-live