Informal Economy

It is likely that you have participated in the informal economy before, especially when you were younger. Have you ever cut a friend's hair for a few quid? How about mowing a neighbour's lawn or shovelling snow? Or maybe you ran a lemonade stand. If we had to take a guess, we'd assume your lemonade stand was not evaluated by a health inspector, you didn't have a business license, the friends who helped you weren't given any tax documents, and your profits were not reported to the government. 

Informal Economy Informal Economy

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Table of contents

    Welcome to the informal economy. We'll take a look at different jobs, examples, and causes of informal economic activity, and discuss its benefits and disadvantages.

    Informal Economy Definition

    You can think of informal economic exchanges as the most rudimentary form of capitalism (the exchange of capital) in that they are simply an interpersonal exchange of private goods for money without any third-party involvement. It's the barter system, but with money. This is as basic as capitalism gets.

    The informal economy includes all of these informal economic exchanges around the world.

    The Informal Economy: The collection of economic activity that occurs outside of any formal regulation, observation, or taxation by a government.

    The informal economy may also be called the grey economy or, more commonly, the informal sector.

    Informal Economy Jobs

    Much of the informal economy revolves around rather mundane retail sales and services that are simply not registered with the government. This may be because the government is not diligent in enforcing its own laws, or it may be because the workers are actively trying to avoid taxation or oversight. On the other hand, it's entirely possible that many workers are not even aware that their activity is considered 'informal' – the lack of government oversight and accountability may simply be the norm where they live.

    Collectively, these types of informal economy jobs are sometimes colloquially called 'under the table' work or 'off the books' work. Almost any type of work can fall into this category. However, here are some of the most common jobs:

    • Day labouring.

    • Unregulated market booths.

    • Unregulated street vendors.

    • Unregulated food sales.

    Informal economy unregulated street vending StudySmarterFig. 1 - A street vendor sells to teens in Kuala Lumpur, Malaysia

    However, the informal economy also includes goods and services that some portion of the public is willing to pay for, but a government refuses to officially sanction (for better or worse). The item or activity itself is illegal – so it would be confined to the informal economy regardless. This portion of the informal economy is often called the black market. Depending on local laws, this category can include:

    • Illegal drug (and/or alcohol) trade

    • Prostitution and sex work

    • Illegal arms deals

    • Wildlife trade, including items like ivory, rhino horns, and pangolin scales

    • Protection racket (taking money from others in exchange for no violence or property damage)

    • Sale of counterfeit (fake) goods

    • Gambling

    • Slavery and the slave trade

    Informal Economy Examples

    Let's look at a few informal economy examples using the jobs described above. First, we'll start with the 'under the table' example:

    Suppose you live in Michigan, USA. A family friend has asked if you want to help him with some part-time work at his custodial company for the summer. To avoid taxes, he never fills out the paperwork that would make you a legal employee. You are paid entirely in cash, and because you are not officially 'on the books' with the company, you also never receive government benefits for your work. When you file your taxes in April of the next year, you do not mention this income. If you or your family friend were to be audited, you would likely be in serious trouble for violating labour and tax laws.

    In developed countries, the above example can be common amongst children below the legal working age (13 in the UK and 14 in the US) and undocumented immigrants, as neither group can legally register their earnings with a government. This puts both groups in a position to be taken advantage of if/when they want or need to work, but such an arrangement need not necessarily be entirely wrong or unfair. Think of the examples in the introduction. A child running her own lemonade stand informally is not on par with a child being forced to toil in a factory informally – but both jobs would technically be part of the informal economy.

    informal economy lemonade stand studysmarterFig. 2 - These children are technically participating in the informal economy

    What about a country where 'off the books' work and sales are a bit more commonplace?

    You are visiting an open-air market in Uganda. A woman operating a booth offers to sell you some beautiful fabric. You haggle a bit on the price, and then you finalise the purchase. There was no sales tax or receipt. You notice that most of the other booths in the open-air market are operating in a similar manner. No one seems to care, and if you asked about why the retail sales are not standardised, reported, or taxed, most people would likely shrug.

    How about something a bit more nefarious? An example from the black market:

    You are now visiting an open-air market in China. People are selling food and clothing when suddenly you come across a cage with a dead pangolin in it. You surmise that it is a Cape pangolin (Smutsia temminckii) from South Africa, whose keratin-based scales are prized in traditional Chinese medicine. It is illegal to hunt pangolins in South Africa, it is illegal to traffic pangolins internationally, and it is illegal to sell pangolins in China. If the vendor were to be reported, she would likely receive a fine.

    What is the difference between the three examples? It is not illegal to do custodial work, but the employment was never formally registered. It is also not illegal to sell fabric, but the sale was never formally registered. However, the sale of the pangolin was illegal, and as such, the sale can only ever be informal; such an activity cannot legally be registered formally as part of the world economy.

    Formal and Informal Economy

    The key difference between the formal and informal economy is what we just mentioned above; formal economic activity takes place within the 'official' world economy, while informal economic activities occur outside of it. You can think of this as the difference between the football matches that are taking place between officially registered clubs versus a football match between some unknown players at a small local park.

    The world economy, also called the global economy or world system, is the sum of all formal economic activity. The global economy binds our domestic businesses and governments together and helps us understand trading relationships (including economic dependencies) amongst the global community. The informal economy is simply not officially part of this.

    Domestically, formal economic activity is subjected to government scrutiny. This allows two things: taxation and labour rights. Income earned as part of the formal economy is taxed by your domestic government(s), allowing those governments to fund their budgets, which usually include various public services, law enforcement, and the military. When you register employment, you are also entitling yourself to certain rights as a worker that your government will (or should) enforce on your behalf, including things like safe and humane working conditions, a minimum wage, equality of opportunity, and avoidance of forced labour. In the informal economy, you have neither taxes nor labour rights.

    Causes of Informal Sector

    Why do people even participate in the informal economy, to begin with? What are the causes of the informal sector?

    Based on everything we've mentioned so far, you can probably estimate a few reasons:

    • People are unwilling to participate in the formal economy (desire to avoid taxes).

    • The nature of the activity is casual/unofficial (lemonade stand in a suburban neighbourhood).

    • The local community has adopted an informal attitude toward economics.

    • People are unable to participate in the formal economy (undocumented immigrants; children below working age).

    • The activity is illegal, so it cannot legally be part of the formal economy.

    • The local government lacks the infrastructure or willpower to enforce formality in economics.

    Informal Economy in Developed Countries

    The informal economy plays a very large role in the least developed and developing countries, as they are more likely to lack the infrastructure necessary to support the formal economy. For some less developed countries, most, if not all, of their tertiary sector activity (service and retail) may take place within the informal economy.

    Informal economy roadside vending StudySmarterFig. 3 - A series of informal roadside market booths in Mombasa, Kenya

    That's not to say that the informal economy does not play a role in developed countries. In fact, it is estimated that over 12% of the UK's GDP comes from activity in the informal economy, with around 2 million people working in the sector (2017).1 This includes work from undocumented immigrants in agriculture and construction, but it also includes black market activities.

    Benefits of Informal Economy

    Perceived benefits and disadvantages of the informal economy are a matter of perspective. You may have read this explanation and thought, 'Wow, no taxes? I can just be responsible for myself? No government can tell me what I can or cannot buy?' and decided the informal economy sounded pretty great. Or you may have read this explanation and decided that the informal economy sounds dangerous, risky, and precarious.

    So, depending on your perspective, the benefits of the informal economy can include the following:

    • People (especially self-employed merchants and vendors) can support themselves monetarily even when formal economic systems are not in place (self-sufficiency).

    • Avoid paying taxes to an incompetent or corrupt government.

    • Provide services or goods that are desired by the general public but not sanctioned by the government.

    • Protection and preservation of local community and culture by circumventing the world system.

    Of these benefits, the first bullet point is probably the most important: the informal economy lets people survive when the formal economy is not up to par in an area.

    Disadvantages of Informal Economy

    Disadvantages of the informal economy include the following:

    • Taxes are not being fed into any government system, reducing a government's ability to provide any social services or public programs to its citizens.

    • Complete lack of third-party scrutiny or accountability, leaving informal economy employees vulnerable to exploitation.

    • Black market employees (especially prostitutes and sex workers) are particularly vulnerable to manipulation because they are, in the eyes of the law, criminals, so they cannot seek outside help if they are being exploited or endangered.

    • The lack of formal health inspection of food vending means food in the informal economy is not guaranteed to be safe for consumption.

    • Spread of illegal goods and activities that can bring harm to society.

    Informal Economy - Key takeaways

    • The informal economy is the collection of economic activity that occurs outside any formal regulation, observation, or taxation by a government.
    • Informal economy jobs vary widely and include everything from unregulated street vending and unregulated day labouring to the selling of illegal goods and services.
    • Unlike the formal economy, the informal economy takes place outside of our interconnected system of global trade.
    • Informal economic activity may be common in areas where people are unwilling or unable to participate in the formal economy or where there is a demand for illegal goods and services that a government is unwilling to sanction formally.

    References

    1. Dipa Patel20, A prize winning essay: Why it matters to understand the informal economy, LSE, 2017.
    2. Fig. 1: street vendor in Malaysia (https://commons.wikimedia.org/wiki/File:Malaysia_Street_Vendor.jpg), by Joshua T. Garcia (https://commons.wikimedia.org/wiki/User:Joshua_T._Garcia), Licensed by CC0 (https://creativecommons.org/publicdomain/zero/1.0/deed.en).
    Frequently Asked Questions about Informal Economy

    What is the informal economy? 

    The informal economy is the collection of economic activity that occurs outside of any formal regulation, observation, or taxation by a government. 

    What is the difference between formal and informal economy? 

    Formal economic activity takes place within the 'official' world economy, while informal economic activities occur outside of it. 

    What are examples of the informal sector? 

    Informal sector examples include unregulated street vending, day labouring, and the illegal sale of counterfeit goods. 

    Why is the informal economy so important? 

    The informal economy allows tertiary sector employees to survive in areas where the formal economy simply does not have enough infrastructure. 

    What are the characteristics of the informal economy? 

    The informal economy is characterised by activities that are occurring outside of the formal economy because they are illegal; the parties involved are unwilling or unable to participate in the formal economy; or because an area lacks the infrastructure necessary to support formal economic activity. 

    What are the reasons for the informal economy? 

    The reasons for the informal economy include: people are unable or unwilling to participate in the formal economy; the nature of the activity is casual/unofficial to begin with; and/or the activity is illegal, so cannot be legally part of the formal economy. 

    Test your knowledge with multiple choice flashcards

    True or False: The black market is part of the informal economy.

    The black market revolves around services or the sale of goods that are _______. 

    A friend asks you to come join his lawn mowing business for the summer, but doesn't want to register you as an official employee so he can avoid paying taxes. Is this part of the informal economy?

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    Team Informal Economy Teachers

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