Five Things to Know about the Informal Economy

IMF News, July 28, 2021

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The informal economy is a global and pervasive phenomenon.
Some 60 percent of the world’s population participates in the informal sector.
Although mostly prevalent in emerging and developing economies, it is also an important part of advanced economies.
The informal economy consists of activities that have market value but are not formally registered.
Examples:
- Minibus drivers in Africa, market stands in Latin America, hawkers at traffic lights.
- In advanced economies: gig and construction workers, domestic workers, registered firms that engage in informal activities.
The International Labor Organization estimates that about 2 billion workers, or over 60 percent of the world’s adult labor force, operate in the informal sector—at least part time.
On average, the informal economy represents 35 percent of GDP in low- and middle- income countries versus 15 percent in advanced economies.
Regional variation:
- Latin America and sub-Saharan Africa have the highest levels of informality.
- Europe and East Asia are the regions with the lowest levels of informality.

The informal economy is difficult to measure because activities cannot be directly observed and participants generally do not want to be accounted for.
Importance: measuring the informal economy matters because of its scale and because it employs some of the world’s most vulnerable people.
Two measurement approaches:
- Direct approach: based on surveys, voluntary replies, and other compliance methods to directly measure the number of informal workers and firms.
- Indirect methods: focus on observable characteristics or proxies related to informal activity (examples: electricity consumption, night-light satellite data, cash in circulation) to measure the share of the informal economy in total output.

The COVID-19 pandemic hit informal workers particularly hard, especially women, because the majority are employed in contact-intensive sectors and in insecure jobs without paid leave or the ability to work from home.
Key figures:
- Close to 95 million more people—many of them informal workers—are estimated to have fallen below the threshold of extreme poverty in 2020 compared with pre-pandemic projections.
- Women make up 80 percent of domestic workers globally, and 72 percent of them have lost their jobs as a result of the pandemic.
- In sub-Saharan Africa, 41 percent of women-owned businesses closed, compared with 34 percent of those owned by men.

Understanding drivers and consequences of informality is central to sustainable and inclusive development because informality is critically related to growth, poverty, and inequality, including gender inequality.
Participation by choice vs necessity:
- Whereas some individuals and firms operate informally by choice, 85 percent of all informal workers are in precarious employment, not through choice but due to a lack of opportunities in the formal sector.
Economic consequences:
- Countries with large informal sectors tend to grow below their potential: informal firms tend to remain small, with low productivity and limited access to finance.
- Informal firms do not contribute to the tax base, depriving governments of resources to provide basic services.
- Informal workers are more likely to be poor and to earn lower wages, lack social protection, lack access to credit, and are generally less educated.
- Gender dimension: Globally, 58 per cent of employed women work in the informal sector and are more likely to be in the most precarious and low-paid categories of informal employment. In sub-Saharan Africa, women’s average share of informal employment in the region’s nonagricultural sector is 83 percent.

A balanced approach is crucial because the informal sector currently represents the only source of income and a critical safety net for millions.
Broad strategy: focus on policies that reduce informality gradually by tackling country-specific drivers (including social exclusion and incentives to operate informally) rather than punitive attacks based on illegality or tax evasion.
Policies found to be effective include:
- Reforms to ensure equitable access to education for boys and girls.
- Increasing access to finance, including by leveraging mobile money and digital reforms.
- Measures to improve the business environment, including:
- Simplifying registration and regulatory requirements for new firms.
- Simple tax systems including easy registration and electronic payment of taxes.
- Labor market reforms.

Source: Five Things to Know about the Informal Economy (July 28, 2021).