According to the International Labour Organization (ILO), the informal economy represents more than half of the global labour force and more than 90 per cent of micro and small enterprises worldwide. ^[1]

Informal economy rates vary from one country to another : according to the United States Agency for International Development it is high as fifty-sixty percent of GDP in countries such as Georgia, Zimbabwe and Bolivia whereas it represents about eight to twelve percent of economic activity in advanced economies.^[2] Indeed, the informal economy trend is mostly a developing country matter, even if developed countries are concerned to a lesser extent. In developed nations, the informal economy is usually confined to economic and commercial activities that would only be carried out by people (house cleaning staff for example), outside the scope of firms. Moreover, the informal economy may be a substitute for the formal economy unemployment in developing countries: people who don’t find jobs in the formal economy are turning to the informal economy . Whereas, developed countries may have had more welfare programs to support their unemployed labor forces, thus unemployed forces don’t have to work within the informal economy to support themselves.^[3] However, this link between informality and underdevelopment should be nuanced. Thus Spain, a ‘developed nation’ had almost 30 % of informal employment within total employment in 2012, according to the International Labour Office.^[4] Moreover OECD points out that in regions such as South Asia and Latin America, the economic growth of the past 20 years was accompanied by an increase in informal employment rates^[5], a trend which relativises the link between economic development and low informal economy rates and question formalization. Indeed, as we will see later, informal economy is a plural phenomenon that can have many different causes. 

Under the 2002 International Labour Conference Resolution and Conclusions on Decent Work and Informal Economy^[6], “informal economy” covers “to all economic activities by workers and economic units that are – in law or in practice – not covered or insufficiently covered by formal arrangements.” Later, the 2015 ILO Recommendation concerning the transition from the informal to the formal economy^[7] specifies that the definition refers to units that employ hired labour, individuals working on their own account and cooperatives and social and solidarity economy units.

It is clear that the initial prevailing position of governments and policymakers encourages formalization. Indeed, as shown, high formalization rates are traditionally linked to prosperity, meanwhile informalization symbolizes underdevelopment. However, researchers have started to condemn this orthodox approach, pointing out the need to approach the informal economy in a more nuanced and realistic way.

Therefore, this article aims to present the existing approaches of the formalization process and its limits (I) and the informal economy approaches (II) in order to have an overview of the challenges for developing countries with high rates of informal economies (III).

I. The formalization process and its limits

Formalization is promoted worldwide (for instance by ILO, World bank, AID) and several formalization policies have been initiated in developing countries (for instance Brazil, Egypt and Palestine). The stated purpose of such policies is to encourage the targeted countries’ development by providing higher quality of life, better paid, and sustainable employment, by building investor confidence, by making the tax base bigger, etc.

The main means used in support of formalization are : light the regulatory and administrative barriers to make the business climate more hospitable to formal enterprise (for instance by simplifying paperworks, use a one-stop-shop approach, etc.), simplify the registration and licensing process (for instance by reducing registration fees and statutory requirements), rationalize the fees and financial requirements (for instance by processing a tax reform and communicate on small companies advantages implied), fight against corruption in public administration, increase business services (for instance by providing micro-finance, better infrastructure, procurement opportunities and other support to informal businesses).

As a matter of fact, means’ results are mixed. For example, according to the United States Agency for International Development, in Montenegro, a program to reduce business registration burden helped increase registered companies from 6,001 in 1999 to 21,724 in 2003, which is a positive result. Meanwhile in 2001, Tanzania introduced a new, simplified taxation schedule in order to encourage micro and small enterprises to become formal. The information was not disseminated, and informal economy actors continue to be unaware of the new schedule leaving them dependent on the integrity of Tanzania Revenue Authority officials.^[8] Also, Mexico has introduced a one-stop-shop reform that has resulted in a 5 % increase in the number of new companies registered, but the International Labour Office points out that the policy did not result in existing informal companies’ registration and formalization.^[9] Finally, Mullainathan and Schnabl conclusions show that municipal licensing reform in Lima (Peru) increased number of provisional licenses issued to informal enterprises, but many enterprises do not renew their license later^[10].

Thus, the formalization policies reveal quite limited results in developing countries and several overall studies confirm formalization's limits. A meta-analysis conducted by Floridi, Afewerk Demena and Wagner on the impact of formalization policies resulting in 842 estimates from 27 studies conducted by 49 researchers and published until June 2019^[11] has concluded no evidence for increased formalization associated with the so far implemented interventions. In accordance with Sweidan’s conclusions^[12], study points out that formalization policies are more effectives within countries having economic freedom. Better legal systems and property rights are also key factors.

Moreover, a study conducted by Rocha, Ulyssea and Rachter about a large-scale formalization program in Brazil^[13] concludes to no incomes’ increase for those who formalised in the short run. According to the study, small firms would perceive limited benefits from formalization, even though they observed an increase of formalization implied by a tax burden reduction.

Finally, Floridi, Wagner and Cameron argue that policies aiming at formalization processes misrepresent the realities of significant numbers of firms in Egypt and Palestine. Consequently, policies over the last twenty years have given little attention or excluded small and medium enterprises in both countries. ^[14]

Looking at these conclusions, it is important to recognize that the formalization policies have unquestionably limited results for developing countries. Looking at the informal economy in a more realistic way would be the first step to go beyond this problem (II).

II. The need of a plural approach of the informal economy

The previous findings about formalization limits has driven researchers to see the concept as a plural phenomena that can be covered by several approaches:

The Dualist approach : Dualist approach is the most classical one. According to it, the formal and the informal economy are part of two distinct spheres. The informal economy is seen as a residual component of the formal economy that has no link with formal one. It is a subsistence economy that only exists because the formal economy is unable to provide sufficient jobs. For example, in some deprived rural areas, households remain untouched by the formal economy, their only way of subsistence is “subsistence farming” and they don’t have access to the formal labour market, which is located in developed urban areas.

This approach suggests that goods and services are increasingly being produced and delivered through the formal economy while the economy is developing. Meanwhile, “traditional” informal work is disappearing while the country is developing. According to this vision, the informal economy is seen as a form of underdevelopment. This theory suggests that growth is only made by highly productive formal firms.

The Structuralist or By-product approach: Unlike the Dualist approach, the Structuralist approach emphasizes the interdependencies between the informal and formal sector. According to this Marxist-inspired approach, the informal sector is integrated into the capitalist system in a relationship of subordination. The informal economy provides labor and cheap products to formal enterprises, thus the informal sector increases the flexibility and competitiveness of the economy.

Indeed, due to the emergence of a deregulated open world economy, informal work is expanding and linked to formal work. This results in subcontracting low pay in some countries, for instance in the textile manufacturing field and it affects marginalized categories of workers (women, children, disabled, etc.) who are excluded from the formal economy. Indeed, according to the International Labour Organization textile production is generally subcontracted to suppliers in different countries (such as Bangladesh), leading to a forceful competition that brings costs down.^[15]

The Alternative or Complementary approach : This approach contrasts with the previous two, since the choice of informality is voluntary. According to this point of view, the informal economy has positive attributes and impacts compared to the formal economy, thus some workers choose it instead of the formal one. There would be more autonomy, flexibility and freedom in this sector than in the formal economy. Thus, many firms deliberately decide to stay informal due to the higher benefits compared to operating formally. This allows them to escape heavy public regulations or excessive costs of legalization associated with formal status and registration.

Furthermore, this approach can be linked to socio-cultural factors, especially when the people consider the state to be weaker than strong informal networks or there is a collective experience of state-oppression. For example, in some post-soviet societies like in Ukraine, a huge part of the informal sector is made by “paid favour”: people make money while providing a service to people they know. This way, the money is redistributed in a way that does not appear to be “charity”, developing or cementing community and social ties^[16].

The Continuum model: According to this vision, there are continuum of economic activities having different degrees of formality. ILO has adopted this approach in the above-mentioned 2002 Recommendation.

Informal economy is not only the set of employment activities within the informal sector. Indeed, the continuum model includes informal and casualised employment within the formal sector. This approach allows grey areas where economic activity combines characteristics of the formal economy and the informal economy.

Indeed, formalization can be a gradual process, for example a business in China may not be registered as a business with the central government, but nonetheless comply with many local regulations.^[17] This approach is also applicable to workers in the formal economy who receive undeclared wages, or to workers in formal enterprises whose working conditions or remuneration are informal (undeclared and unpaid overtime for instance).

To take in account all these approaches while studying the informal economic phenomena presents the advantage to have a realistic and nuanced way of a country's situation. Indeed, to admit informal economy as something other than an underdevelopment stage permits us to study the phenomena in light of socio-cultural specificity of countries. For instance, according to Willams and Round, in Ukraine a number of households are pursuing subsistence modes of production, especially in deprived rural areas because of a lack of choice. This situation can be linked to the Dualist approach. However, self-employed informal work is mostly a choice in Ukraine (9 on 10 times) and 55% of all undeclared work identified in their survey is composed of paid favours for friends, neighbours and kin ; 41% of it involved payment. This situation is represented by the complementary or alternative approach. Thus, eradicating such paid favours, according to Williams and Round, would eliminate nearly half of all acts of one-to-one reciprocity and lead to a diminution of community self-help and consequently social cohesion.^[18]

Finally, evidence can be found for each representation but no one representation can represent the whole informal economy. This observation shows that systematic formalization is not a pertinent answer to informal economy (III).

III. Conclusions and policy implication

To conclude, considering the informal economy as plural is crucial since it would help identify which forms of informal work that need to be eradicated and those that need to be tacitly tolerated. Indeed, the simplistic debate “formalization or informalization” has put many small and medium informal enterprises aside until today.

Thus donors and researchers should make themselves aware of the different approaches to the subject and conduct wise cooperative research about their informal economy, moving beyond an employment-centred discourse.

Once the overall vision of the informal economy is highlighted, policies should aim to recognize the part of the informal sector that constitutes a valid alternative to formalization and give it visibility and potential to grow. Such policy making should include informal economy actors in the process to obtain a pertinent strategy.

An article  was prepared in the framework of the Project – "Improving the rights  of employees in the formal and informal sectors". The Project is funded by the Open Society Georgia Foundation (OSGF)

The opinions expressed in the article are the sole responsibility of the author and may not express the position of the Open Society Georgia Foundation (OSGF)