The
concept of informal economy refers to economic activities that are carried out
outside of an existing framework of public and private regulation. (Hart 845)
It can further be defined as the “existence of unorganized, unregulated, and
mostly legal but unregistered” labor (Todaro 328). Informal economic activities
amount to significant sources of income in many third-world countries, and they
occur alongside “formal” economy activities that are regulated and protected
under established law. Productivity in the informal sector is often
substantial, yet goes unaccounted for by traditional comparative economic data;
evidencing significant miscalculations in aggregate economic productivity.
(Todaro 328) An understanding of economic informality can promote a better
understanding of the failures and limitations of traditional economic measures,
and can give insight into the benefits and drawbacks of the existence of the
informal sector. This paper will examine the growth of the concept of
informality, discuss the theoretical disagreements on its basis and influence,
and will conclude by arguing that informality represents a positive source of
entrepreneurship, and as such, should be promoted by public policy.
The notion of the informal economy
emerged out of the context of dualistic models of economic development. W.
Arthur Lewis’ theory of development was one of the leading models that emerged
within this paradigm, and it explained the process of the growth of urban
employment by the withdrawing of laborers from the rural, traditional sector by
the incentive of higher wages paid in the modern sector (Hart 845). Another
influential model was that of Harris and Todaro, which sought to explain the
paradoxical relationship between accelerating urban migration and the rising
instances of urban unemployment in African cities during the 1960s; finding
that migrants future expectations of rising incomes acted as the primary
inducer for them to relocate to cities. (Hart 845, Todaro 339)
In 1973, economist Keith Hart observed that many of these
so-called “unemployed” city-dwellers were actually employed in a
non-traditional sense, devoid of state regulation; and he proposed a dualistic
model of employment within urban labor forces; introducing the conceptual
divergences between formal and informal economic activities. (Hart 845, Portes
427) His model grew out of the framework of Weber’s theory of rationalization,
which saw the strengthening of state bureaucracy and the formalization of
economic processes to be necessary in order to ensure societal order and
predictability. (Hart 845) In contradiction to Western sociological thought and
its preconceived notions embedded in modern economics, he found that many of
the previously considered “unemployed” inhabitants of cities were in fact
involved in a multitude of income-generating activities. These activities
ranged from street vending and the performance of menial and labor-intensive
services to their offering of dynamic and well-developed entrepreneurial
skills; and he labeled such workers as part of the “informal economy” (Todaro
328, Portes 426, 427).
Hart observed that labor in the informal sector had both
advantages and disadvantages; in that informal employment allowed workers a
method by which to circumvent government regulation and taxes, yet its workers
were forced to cope without access to a legal system to protect and secure
their occupational positions, prevent them from having to work under unsuitable
working conditions, and secure traditional working benefits. (Todaro 329)
Nevertheless, Hart perceived participation in the informal economy from a
positive perspective, seeing it as a method for otherwise unemployed
individuals to insure the means to their own sustenance by allowing them to
“[take] back in their own hands some of the economic power that centralized
agents sought to deny them” (Portes 427).
Hart’s revolutionary theory paved the way for a significant
growth in theoretical discourse on the subject of informal economy from the
time of its founding to the present. Notable disagreement has emerged regarding
the proper definition of informal economy and the extent of its influence on
economic productivity, both from normative and positive theoretical
perspectives. Although Hart’s theory saw informal economic activities as
dynamic and vibrant, the concept was interpreted by the institutionalized
bureaucracy of the International Labour Office as “synonymous with poverty,”
characterized by low productivity and little to no accumulative capacity
(Portes 427). By the late 1970s, Marxists criticized its proponents by arguing
that informal economic activities are “essentially regressive and exploitative”
(Hart 845). The notion of an informal workforce stood in contradistinction to
traditional, societal conceptions of economic analysis. However, some prominent
economists have maintained the positive spirit of Hart’s original conception.
One such economist was Peruvian economist Hernando de Soto, who criticized the
existence of powerful and overregulated “mercantilist” states in Latin America;
viewing intensive state regulation as “arbitrary” and the growth of economic
informality as a viable alternative to the status quo (Losa xxvii).
At the same time, economists have attempted to find some
middle ground by describing and defining the extent of informal economy, absent
of normative evaluation. This effort resulted in the widely accepted conclusion
that the informal economy includes income-generating activity that “fails to
adhere to the established institutional rules or are denied their protection”
(Portes 427). Feige sought to further define the concept by classifying
economic activities into four categories and differentiating informal economy from
the others. He found the informal economy to include those activities that
“bypass the costs [of regulation] and are excluded from the protection of laws
and administrative rules” (Portes 428). Feige’s definition saw informal
economic activities to have illegality in the process of production itself, yet
legality in the final product or service. He distinguished between the informal
economy and the “illegal economy,” characterized by the production of products
or services that are on their face illegal, the “unreported economy” identified
as production processes that circumvent the tax code yet are otherwise legal,
and the “unrecorded economy” which includes economic activity that simply fails
to be accounted for by official government statistics (Portes 428). Portes,
Castells and Benton further defined informal economic activities by analyzing
the ends in which they seek to achieve; finding that such activities can be
directed at either mere survival, at reducing the managerial costs associated
with formal economic activity, or at taking advantage of the absence of a
regulatory environment for the purpose of accumulating capital. (Portes 429)
Gershuny and Pahl developed another conceptualization; theorizing that
production performed at home is part of the domain of the informal economy if
it replaces marketed goods and services. (Portes 429) Thus, there has been
significant disagreement on the definition and extent of the informal economy.
In an influential effort to describe the socioeconomic
functioning of the informal economy, Alejandro Portes identified three
paradoxes. First, he noted that “the more [informal economy] approaches the
model of the true market, the more it is dependent on social ties for its
effective functioning” (Portes 430). In other words, as informal economic
activities become commonplace, there becomes “little need for hierarchical
oversight” as the primary enforcement mechanism becomes the fear that violators
of “mutual trust” will be excluded from future participation in such economic
“networks,” or series of interconnected informal economic activities (Portes
431). Portes’ second paradox of the informal economy is that the more the state
seeks to regulate informal economic activities, the greater the informal
economy grows. (Portes 433) This is founded on Adams’s anti-statist argument
that asserts that the greater the extent of government regulations, the greater
is their tendency to “generate resistance on the part of the governed” (Portes
433). This theory is supplemented by the contributions of Roberts, who
attributes varying degrees of informality to historical and cultural
divergences between societies and the existence of a flourishing civil society,
or lack thereof. (Portes 434) Portes’ third and final paradox is that the greater
the credibility of the state’s economic regulatory regimen and recordkeeping
capabilities, the greater is the likelihood that that such records will fail to
account for the extent of informal economic activities. (Portes 443)
Underestimations of the complexity and size of the informal sector can lead to
uniformed and inappropriate public policy. As a concept that is by its nature
not easily quantifiable, it is difficult if not impossible to move beyond the
level of abstraction in defining its extent. Yet some scholars have estimated
that in many third-world cities, informal sector employment constitutes between
thirty and seventy percent of total employment; demonstrating its scope
relative to the formal sector. (Todaro 328) Thus, the notion of economic informality
and its importance as a means of productivity in the third world and beyond has
rightfully fostered the growth of a diverse body of theoretical analysis.
The contribution of informality to society is considerable,
and as such, should be promoted and not hindered by public policy. First, in
developing countries, the existence of informality serves to offset the
economic unproductiveness of labor that cannot be absorbed by the formal
sector. The informal sector has proven itself capable of providing those
otherwise unemployed with a sustainable source of income, thus reducing the
burden on governments of providing for social justice. Furthermore, informality
affords a society a mechanism by which to accumulate human capital, as informal
economic activities afford its partakers access to valuable training that would
otherwise be unavailable to them. (Todaro 332) Additionally, the informal
economy makes use of appropriate technologies and recycles wasted materials;
adding to the aggregate productivity of an economy and employing its available
resources to their fullest use. (Todaro 332)
Finally, the informal economy affords its participants a sense of
political empowerment, as participation in the sector allows them to free
themselves from the chains of overregulation (Losa xxvii). Allowing the
informal economy to exist can thus be conducive to social harmony and political
stability.
Some may argue that the growth of the informal sector is the
result of the failure of third-world economies to create decent jobs. This may
be true; however in many third-world cities, it is an unreasonable expectation
that in the formal sector, full employment can be achieved and maintained in
light of tremendous population growth. Studies have shown that the job market of
the formal sector would need to expand at a rate of ten percent annually in
order to provide sufficient jobs in third-world cities, an unlikely prospect.
(Todaro 331) There are some disadvantages to allowing for an informal sector to
flourish, however they are nevertheless outweighed by its benefits. One
negative often alleged is the fact that by promoting an informal sector,
migrants are encouraged to relocate to cities that may lack the resources to
absorb their labor either in the formal or informal sector. (Todaro 332)
However, much of the productivity in the informal sector is based on one’s
ability to utilize their entrepreneurial skills and find innovative ways to
generate income. Thus, those that join the ranks of the informal economy would
face similar competitive pressures as would those in the formal economy; and
the prospect of increased competition should not on its face be a sufficient
reason to justify curtailing informal economic activities. A second argument
that is often made against supporting the informal economy is that its
continuation and concentration in urban areas threatens the environment;
alleging that informal economic activities generate pollution and congestion.
(Todaro 332) However, a government
needing to clean up pollution is perhaps a far lesser cost to pay than would
the burden be of having to cope with millions of concentrated, unemployed
citizens that are forced to resort to criminal activity to sustain their
existence. For these reasons, governments in the developing world should seek
to perpetuate and encourage the growth of the informal economy.
In conclusion, informal economy is a concept conceived by
Keith Hart in the context of African urban development in the 1970s. By using a
dualistic approach, Hart theorizes that urban economic activities can be
divided into a formal sector, characterized by formal organization and
regulation; and an informal sector, characterized by productive activities that
are in of themselves legal, but are produced and distributed absent of public
and private regulation. Since its founding, the concept of informal economy has
undergone a series of theoretical evaluations, resulting in substantial
disagreement over its value as an independent concept and its existence as a
form of economic progress. Although difficult to quantify, studies have shown
that informal economic practices make up a substantial portion of productivity
in many third-world countries, and is thus an important variable in assessing
their development. The informal economy can be viewed as having a positive
entrepreneurial contribution on third-world economies. Its support and
perpetuation can be seen as a method by which governments can reduce their
burden of having to provide for its poor and unemployed citizenry and can promote
economic efficiency by ensuring that resources that would otherwise go
unutilized are used to their fullest extent. Although the informal economy can
produce pollution and encourage an unmanageable amount of migration to cities,
it should nevertheless be allowed to sustain as the prospects of its
discontinuance would be far worse than having to overcome these comparatively
more-controllable consequences. An analysis of informal economy can give one
insight into the shortcomings of traditional economic measures, and can provide
one with a unique understanding of developing economies.
Works Cited
Hart, 1998,
“Informal Economy,” The New Palgrave
A Dictionary of Economics, Edited by Eatwell, John, Milgate, Myrray, and
Newman, Peter, Vol. 2, pp. 845-846.
Todaro, Micheal, Economic Development. Pp. 328-333.
Losa, Maria Vargas, 1989, “ Forward” in De
Soto, Hernando, The Other Path: the
Invisible Revolution in the Third World.
New York, Harper and Row, pp. xxiii-xxvii.
Portes, Alejandro, 1994, “The Informal
Economy and Its Paradoxes.” in The Handbook of Economic Sociology in Smelser, Neil J. & Swedberg, Richard
(eds.) Princeton, Princeton University Press, pp. 426-449.
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