Informal Labor: Business as Usual?
Written by Lynn Hamerlinck on 12 July 2021
Here in Europe, the summer holidays have started. If you are traveling this year, perhaps you already arrived at your destination. After buying a refreshing sangria from a street stall, you are happy to purchase the straw sun hat you forgot at home from a vendor at the beach. You now have supported two informal workers who are working hard to make ends meet. They work in the informal economy, where it may seem like business as usual for us, but is it for them too?
The International Labor Organization estimates that over 2 billion workers worldwide are active in the informal sector. The informal economy is the diversified set of economic activities, enterprises, jobs, and workers not regulated or protected by the state. People who work in this informal or grey economy are often left without the protection of labor laws, secure contracts, social benefits such as a pension, health insurance, or paid sick leave.
Working in this unprotected labor market is mainly concentrated in developing countries, where 90% of workers operate informally, and emerging markets, where informal labor is making up 67% of workers. Even in mature markets, like the Netherlands, 18% of workers are active in the informal economy.
Even though workers in the informal economy are not by definition poor, most of the 1.7 billion poor in the world depend exclusively on their labor for survival. And as informal employment remains particularly problematic in developing countries, this emphasizes the importance of employment for poverty reduction and economic development.
Myth: Informal workers only act in a shadow economy
Different terms, such as “cash-in-hand”, “hidden”, “shadow”, and “unregulated”, are used to refer to activities that are part of the informal economy, as they take place in non-formalized space and are unregistered by or hidden from the state for tax and benefits purposes.
But, although the informal economy is characterized by worker vulnerability, it contributes to many products and activities we share daily and adds an average of 25% up to 50% of non-agricultural gross domestic product (GDP), depending on the country. Much of the informal economy contributes greatly to the formal economy.
Of those working in the informal economy, there are self-employed people in informal enterprises - such as workers in small unregistered companies or unpaid family workers, and informal employees - such as workers who work for households, employees with no fixed employer, and unregistered workers. Some people are self-employed in the informal sector to avoid registration and taxation, but many people work in the informal economy through necessity rather than choice.
Informal workers in developing countries make up more than half the workforce. They receive low wages and no formal contracts or benefits, yet often represent the most dynamic part of the economy. Even if there’s huge potential for economic growth by formalizing the informal sector, it is important to acknowledge the untapped reservoir of entrepreneurial energy the sector holds. Businesses and workers in the informal economy are flexible and creative, ranging from basic labor for survival to skilled craftwork. Mainly in developing and emerging countries, the sector creates massive employment and income opportunities.
It is interesting to look at the background, barriers, and aspirations of these workers. For many youths, an informal job can mark entry into the labor market, since they lack the resources to search and apply for jobs. Informal activities can also increase one’s income; teachers, for example, often give private classes to children from middle- or upper-class families informally.
Research by Women in Informal Employment: Globalizing and Organizing (WIEGO) has shown that people from poor households tend to be more frequently engaged in informal work. WIEGO found that under an income-based definition, many informal workers belong to the middle class. In Vietnam, 30% of the middle class works primarily in the informal sector. Often entrepreneurs, these worker’s income is relatively far from the poverty line. However, challenges such as lack of housing or limited access to public services are still the order of the day.
Informal work is also linked with gender inequality. Women are over-represented in informal and vulnerable employment, constituting the most precarious, underpaid, informal workers. and are twice as likely as men to be contributing family workers. Previously, we shared how female entrepreneurs are driving GDP growth worldwide and the obstacles that are withholding them from growth.
The Consequences of Working in the Informal Sector
Informal employment has severe consequences for both the worker and society. Beyond earning levels, informal work makes basic rights vulnerable and difficult to defend. As such, it can be a major cause of poverty in dimensions other than income. The OECD determines that most of those who work informally are insufficiently protected from the various risks they are exposed to, such as illness or health problems, unsafe working conditions, and possible loss of earnings.
At the level of society, informal employment undermines the ability of the state to ensure that workers have fair working conditions, including reasonable working hours and safety regulations, and receive adequate and equal pay for equal jobs or skills. Due to persistently high levels of informality, the state misses out on fiscal revenues to develop social security systems based on taxes and contributions.
- The most significant negative consequences of the informal economy for an individual are:
1) Lower income 2) Vulnerable basic rights 3) No health insurance 4) No unemployment benefits 5) Inability to access credit or legal financing
- For society these are:
1) Reduction of fiscal revenues 2) No ability to develop social security systems based on taxes and contributions 3) Slower economic growth
Is formalizing informal work the solution?
Facilitating formalization can potentially promote economic and social development and growth. However, formalization is not the only way ahead. If governments eliminate all informal labor without providing regulated alternatives, this will drive many people into extreme poverty. The OECD helps policymakers deal with this issue and promote more and better jobs for all. They recommend providing support to the working poor in the informal economy, making formal structures more efficient and flexible, and creating more formal jobs.
According to the OECD, states should acknowledge the nature of informal work and break down the range of barriers that prevent workers from obtaining a better livelihood. They can do so with better provision of rights, social protection, and decent work measures. Tailoring policies by understanding the local environment and groups’ needs will benefit those engaged in informal work or those moving between formal and informal worlds.
Addressing informality is thus essential and urgent to support inclusive economic development and reduce poverty worldwide, says the IMF. However, designing effective policies to address informality is complicated by its multiple causes and forms, both across and within countries. Informality responds to a set of country-specific characteristics and institutions, and there is no one-size-fits-all solution.
As such changes may take many years, shorter-term policies and solutions are required. One solution to this situation is growing the legal job markets in developing and emerging countries, allowing more workers to come into the formal, protected economy. Another solution is through enabling participation, as seen at Warwick Junction Market in Durban, South Africa. The market is made up of more than 7,000 informal vendors who were able to give their input to re-engineer the market infrastructure and obtain their trader rights through legal assistance.
As an impact investor, you can contribute to creating jobs in emerging markets by investing through crowdfunding platforms like Lendahand, which helps small entrepreneurs to grow their local economies. You can invest in MFIs, microfinance institutions, which allow these tiny businesses, rural women, and low-income households access to finance to grow their businesses and better their communities’ living conditions.
Stay tuned for an overview of the MFIs in our portfolio coming soon.
Williams, Williams and Martinez