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Workers in the Informal Economy

Workers  in the Informal Economy picture

The informal economy refers to activities and income that are partially or fully outside government regulation, taxation, and observation. The main attraction of the undeclared economy is financial. This type of activity allows employers, paid employees, and the self-employed to increase their take-home earnings or reduce their costs by evading taxation and social contributions. On the one hand, informal employment can provide a cushion for workers who cannot find a job in the formal sector. But, on the other hand, it entails a loss in budget revenues by reducing taxes and social security contributions paid and therefore the availability of funds to improve infrastructure and other public goods and services. It invariably leads to a high tax burden on registered labor.
A high level of informality also can undermine the rule of law and governance. The fact that a large share of the population is openly ignoring laws, regulations and taxes can weaken the respect citizens have for the state.

The informal sector is a pervasive and persistent economic feature of most developing economies, contributing significantly to employment creation, production, and income generation. Recent estimates of the size of the informal sector in developing countries in terms of its share of non-agricultural employment range roughly between one-fifth and four-fifths. In terms of its contribution to GDP, the informal sector accounts for between 25% and 40% of annual output in developing countries in Asia and Africa.

There are various reasons why governments may be concerned about large informal sectors. These include potentially negative consequences for competitiveness and growth, incomplete coverage of formal social programs, undermining social cohesion and law and order, and fiscal losses due to undeclared economic activity. For most governments, these concerns outweigh any advantages that the informal sector offers as a source of job creation and as a safety net for the poor.

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Related Employment Policy Primer Papers

Population Aging and the Labor Market: The Case of Sri Lanka (304kb pdf)
Social Protection Discussion Paper No. 0821
Vodopivec, Milan and Arunatilake, Nisha
August 2008

Sri Lanka’s population is predicted to age vary fast during the next 50 years, bringing a slowdown of labor force growth and after 2030 its contraction.  Based on a 2006 representative survey of old people in Sri Lanka, the paper examines labor market consequences of this process, focusing on retirement pathways and the determinants of labor market withdrawal.  The paper finds that a vast majority of Sri Lankan old workers are engaged in the informal sector, work long hours, and are paid less than younger workers.  Moreover, the paper shows that labor market duality carries over to old age: (i) previous employment is the most important predictor of the retirement pathway; (ii) older workers fall into two categories: civil servants and formal private sector workers, who generally stop working before they reach 60 because they are forced to do so by mandatory retirement regulations, and casual workers and the self-employed, who work until very old age (or death) due to poverty and insufficient income and who stop working primarily because of poor health; and (iii) the option of part-time work is used primarily by workers who held regular jobs in their prime age employment, but not by casual workers and self-employed.

A Guide to Multisector Labor Market Models (433kb pdf)
Social Protection Discussion Paper No. 0505
Fields, Gary S.
April 2005

This paper approaches labor markets through multisector modeling.  The first main substantive section presents the essence of multisector modeling, in particular, the role of labor market dualism. Given that labor markets often consist of quite distinct segments, a useful and insightful analytical approach is to start with just two interrelated segments.  The second main substantive section is on models of wages and employment in the formal economy.  This section covers 1) the market-clearing labor market model and the presumed equilibrating forces, 2) above-market-clearing wages set institutionally, 3) above-market-clearing wages set by efficiency wage considerations, and 4) above-market-clearing wages set by worker behavior.  The third main substantive section is on wages and employment in the informal economy.  This section presents three characterizations of informal sector labor markets: 1) the informal economy as a free-entry sector that prospective workers enter only as a last resort, 2) the informal economy as a desirable sector that workers choose in preference to formal sector work, and 3) the informal economy with its own internal dualism, combining 1) and 2).  The fourth section is on intersectoral linkages.  The models here are: 1) the integrated labor market model with full market clearing, 2) crowding models, and 3) the Harris-Todaro model.

The Other Side of Self-Employment: Household Enterprises in India (147kb pdf)
Social Protection Discussion Paper No. 0318
Das, Maitreyi Bordia
September 2003

Non-farm household enterprises are important for a number of reasons to do with poverty and employment creation. They could either be the first unit of micro-entrepreneurship or a coping strategy for the poorest. Either way, over 11% of India's prime working age population is self-employed in these enterprises. Moreover, they are important also because they are most likely to be informal business ventures and deserve study on all these grounds.

Based on data from the Indian National Sample Survey, 50th Round, this paper analyzes the characteristics of individuals operating non-farm household enterprises.  It addresses the question – do high skilled and highly educated workers set up these enterprises or are they operated by individuals with low levels of education, working in low status occupations?  To what extent are the occupations in household enterprises segregated by sex?  Through descriptive, bivariate and multivariate techniques, it demonstrates that household enterprises comprise a highly heterogeneous set of occupations. In rural areas, they are likely to be absorbing the supply of educated labor from among those who do not have access to land. In urban areas, self-employment in household enterprises could be more in the nature of a survival strategy for individuals with lower levels of education.  Moreover, they are segmented along religion, caste and gender.  Muslims, upper caste individuals and men are more likely to be self-employed in them.

Extending Social Protection to Informal Workers in the Horticulture Global Value Chain  (219kb pdf)
Social Protection Discussion Paper No. 0216
Barrientos, Armando; Barrientos, Stephanie Ware
July 2002

This paper looks at issues surrounding the extension of social protection to workers in the horticulture sector. This sector involves a significant level of informal employment, with high levels of insecurity and social risk, but low levels of income and social protection. Workers in this sector and excluded from existing coverage or benefits. Using a global value chain approach, and a social responsibility matrix, this paper explores both the current weaknesses but also potential opportunities for extending social protection to this group of workers.

Social Protection and the Informal Sector in Developing Countries: Challenges and Opportunities (248kb pdf)
Social Protection Discussion Paper No. 0130
Canagarajah, Sudharshan; Sethuraman, S.V.
December 2001

This paper is aimed at identifying the sources of income insecurity and vulnerability among workers in the informal sector in developing countries and examines alternative approaches to social protection for the informal sector. This is followed by a discussion on the challenges of developing a comprehensive approach to social protection for the sector, building on the 2000/1 WDR on poverty and the 2001 Social Protection Sector Strategy Paper.

The Informal Sector Revisited: A Synthesis Across Space and Time (80kb pdf)
Social Protection Discussion Paper No. 0119
Blunch, Niels-Hugo; Canagarajah, Sudharshan; Raju, Dhushyanth
July 2001

The concept of the informal sector (IS) has recently received widespread and growing attention. Indeed, it may be fair to talk about a re-emergence of the concept in the debate related to social protection and poverty reduction. We argue that with this new found prominence, it is even more important that we better understand the IS. Only with an improved understanding of the issues and dimensions of the IS can we design policies and programs which effectively address the needs of workers engaged in informal sector activities. This paper is an attempt to contribute to such an increased understanding by highlighting important pieces in understanding the concept of the IS across (1) time, briefly discussing how our view of the concept of the IS has evolved over time and (2) space, presenting empirical evidence and stylized features across regions. After presenting the current state of knowledge of the IS, the authors distill key aspects and issues of the IS and discuss their implications for policy design and implementation, especially in the context of fighting poverty and improving livelihoods of the poor in developing countries.

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Related Links

Informality and Labor Market Segmentation
World Bank Employment and Inclusive Growth

This section of the World Bank's Poverty Reduction and Development Effectiveness Department website is designed to help fill the gap between the awareness of the importance of employment and labor market mobility as engines of development and poverty reduction, and the attention this issue receives in mainstream economic analysis and policy-making.

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