Second economy

The informal sector or informal economy is that part of an economy that is not taxed, monitored by any form of government, or included in any gross national product (GNP), unlike the formal economy.[1]

Other terms used to refer to the informal sector can include the black market, the shadow economy, the underground economy and System D. Associated idioms include under the table, "off the books" and "working for cash".


The original use of the term ‘informal sector’ is attributed to the economic development model put forward by W. Arthur Lewis, used to describe employment or livelihood generation primarily within the developing world. It was used to describe a type of employment that was viewed as falling outside of the modern industrial sector.[2] An alternative definition uses job security as the measure of formality, defining participants in the informal economy as those 'who do not have employment security, work security and social security.”[3] While both of these definitions imply a lack of choice or agency in involvement with the informal economy, participation may also be driven by a wish to avoid regulation or taxation. This may manifest as unreported employment, hidden from the state for tax, social security or labour law purposes, but legal in all other aspects.[4]

The term is also useful in describing and accounting for forms of shelter or living arrangements that are similarly unlawful, unregulated, or not afforded protection of the state. ‘Informal economy’ is increasingly replacing ‘informal sector’[1] as the preferred descriptor for this activity.

Informality, both in housing and livelihood generation has often been seen as a social ill, and described either in terms of what participant’s lack, or wish to avoid. A countervailing view, put forward by prominent Dutch sociologist Saskia Sassen is that the modern or new ‘informal’ sector is the product and driver of advanced capitalism and the site of the most entrepreneurial aspects of the urban economy, led by creative professionals such as artists, architects, designers and soft-ware developers.[5] While this manifestation of the informal sector remains largely a feature of developed countries, increasingly systems are emerging to facilitate similarly qualified people in developing countries to participate[6]


Governments have tried to regulate (formalize) aspects of their economies for as long as surplus wealth has existed which is at least as early as Sumer. Yet no such regulation has ever been wholly enforceable. Archaeological and anthropological evidence strongly suggests that people of all societies regularly adjust their activity within economic systems in attempt to evade regulations. Therefore, if informal economic activity is that which goes unregulated in an otherwise regulated system then informal economies are as old as their formal counterparts, if not older. The term itself, however, is much more recent. The optimism of the modernization theory school of development had led most people in the 1950s and 1960s to believe that traditional forms of work and production would disappear as a result of economic progress in developing countries. As this optimism proved to be unfounded, scholars turned to study more closely what was then called the traditional sector. They found that the sector had not only persisted, but in fact expanded to encompass new developments. In accepting that these forms of productions were there to stay, scholars began using the term informal sector, which is credited to the British anthropologist Keith Hart in a study on Ghana in 1973 but also alluded to by the International Labour Organization in a widely read study on Kenya in 1972.

Since then the informal sector has become an increasingly popular subject of investigation, not just in economics, but also in sociology, anthropology and urban planning. With the turn towards so called post-fordist modes of production in the advanced developing countries, many workers were forced out of their formal sector work and into informal employment. In a seminal collection of articles, The Informal Economy. Studies in Advanced and Less Developed Countries, Alejandro Portes and collaborators emphasized the existence of an informal economy in all countries by including case studies ranging from New York City and Madrid to Uruguay and Colombia.[7]

Arguably the most influential book on informal economy is Hernando de Soto's El otro sendero (1986),[8] which was published in English in 1989 as The Other Path with a preface by Peruvian writer Mario Vargas Llosa.[9] De Soto and his team argue that excessive regulation in the Peruvian (and other Latin American) economies force a large part of the economy into informality and thus prevent economic development. While accusing the ruling class of 20th century mercantilism, de Soto admires the entrepreneurial spirit of the informal economy. In a widely cited experiment, his team tried to legally register a small garment factory in Lima. This took more than 100 administrative steps and almost a year of full-time work. Whereas de Soto's work is popular with policymakers and champions of free market policies like The Economist, many scholars of the informal economy have criticized it both for methodological flaws and normative bias.[10]

In the second half of the 1990s many scholars have started to consciously use the term "informal economy" instead of "informal sector" to refer to a broader concept that includes enterprises as well as employment in developing, transition, and advanced industrialized economies.


The informal economy under any governing system is diverse and includes small-scaled, occasional members (often street vendors and garbage recyclers) as well as larger, regular enterprises (including transit systems such as that of Lima, Peru). Informal economies include garment workers working from their homes, as well as informally employed personnel of formal enterprises. Employees working in the informal sector can be classified as wage workers, non-wage workers, or a combination of both.[11]

The above definition does not include criminal activities, that are irregular by nature. Crime cannot be included because such acts have no regulated counterpart against which they may be compared. (Of course, by their nature, informal economic activities escape regulation but that does not necessarily imply that they are unlawful or criminal). Domestic labor, such as childcare and cooking, is in general not included when performed in the natural course of daily living. These activities are either formal or informal.

Statistics on the informal economy are unreliable by virtue of the subject, yet they can provide a tentative picture of its relevance: For example, informal employment makes up 48% of non-agricultural employment in North Africa, 51% in Latin America, 65% in Asia, and 72% in sub-Saharan Africa. If agricultural employment is included, the percentages rises, in some countries like India and many sub-Saharan African countries beyond 90%. Estimates for developed countries are around 15%.[12]

In developing countries, the largest part of informal work, around 70%, is self-employed. Wage employment predominates. The majority of informal economy workers are women. Policies and developments affecting the informal economy have thus a distinctly gendered effect.

A report from World Bank estimates the informal economies of 162 countries for the years of 1999 to 2007.[13]

Estimated size of countries' informal economy

The table below shows the estimated values of the size of the informal economy in 110 developing, transition and OECD countries.

The average size of the informal economy, as a percent of official GNI in the year 2000, in developing countries is 41%, in transition countries 38% and in OECD countries 18%.[14][15]


Women tend to make up the greatest portion of the informal sector, often ending up in the most erratic and corrupt segments of the sector.[16] Sixty percent of female workers in developing countries are employed by the informal sector.[17] The reasoning behind why women make up majority of the informal sector is two-fold. Firstly, it could be attributed to the fact that employment in the informal sector is the source of employment that is most readily available to women. Secondly, a vast majority of women are employed from their homes (most likely due to the large number of women who are involved in care work) or are street vendors, which both are classified in the informal sector[18] Furthermore, men tend to be overrepresented in the top segment of the sector and women overpopulate the bottom segment.[16] For example, very few women are employers who hire others and more women are likely to be involved in smaller scale operations.[19] Labor markets, household decisions, and states all propagate this gender inequality.[16] The gender gap in terms of wage is even higher in the informal sector than the formal sector[20]

Issues from within

Workers in the informal sector typically earn less income, have unstable income, and don’t have access to basic protections and services,[16][17] at least that seems to be the overall conclusion of research in development and transition economies. Informal businesses also lack the potential for growth, trapping employees in menial jobs indefinitely. On the other hand the informal sector can allow a large proportion of the population to escape extreme poverty and earn an income that is satisfactory for survival.[21] Also, in developed countries, some people who are formally employed may choose to perform part of their work outside of the formal economy, exactly because it delivers them more advantages. This is called 'moonlighting'. They derive social protection, pension and child benefits and the like, from their formal employment, and at the same time have tax and other advantages from working on the side.

From the viewpoint of governments, the informal sector can create a vicious cycle. Being unable to collect taxes from the informal sector, the government may be hindered in financing public services, which in turn makes the sector more attractive. Conversely, some governments view informality as a benefit, enabling excess labor to be absorbed, mitigating unemployment issues.[21]


The informal sector has been expanding as more economies have started to liberalize.[16] This pattern of expansion began in the 1960s when a lot of developing countries didn’t create enough formal jobs in their economic development plans, which led to the formation of an informal sector that didn’t solely include marginal work and actually contained profitable opportunities.[22] In the 1980s, the sector grew alongside formal industrial sectors. In the 1990s, an increase in global communication and competition led to a restructuring of production and distribution, often relying more heavily on the informal sector.[23] Over the past decade, the informal economy is said to account for more than half of the newly created jobs in Latin America. In Africa it accounts for around eighty percent.[24] Many explanations exist as to why the informal sector has been expanding in the developing world throughout the past few decades. It is possible that the kind of development that has been occurring has failed to support the increased labor force in a formal manner. Expansion can also be explained by the increased subcontracting due to globalization and economic liberalization. Finally, employers could be turning toward the informal sector to lower costs and cope with increased competition.

According to SIDA, the key drivers for the growth of the informal economy in the twenty-first century include:[1]

  • limited absorption of labour, particularly in countries with high rates of population or urbanisation;
  • excessive cost and regulatory barriers of entry into the formal economy, often motivated by corruption;
  • weak institutions, limiting education and training opportunities as well as infrastructure development;
  • increasing demand for low-cost goods and services;
  • migration motivated by economic hardship and poverty; and
  • difficulties faced by women in gaining formal employment


The relationship between the informal sectors and poverty certainly isn’t simple nor does a clear, causal relationship exist. An inverse relationship between an increased informal sector and slower economic growth has been observed though.[16] Average incomes are substantially lower in the informal economy and there is a higher preponderance of impoverished employees working in the informal sector.[25]

Possible improvements

Ways to improve the informal sector include formalizing informal jobs through regulation by the state. The issue with this policy is that so many different types of informality exist. It would be extremely difficult to create solutions to meet so many diverse circumstances. Another possible improvement would be to provide better protections and benefits in the informal sector, but creating protection programs could lead to a disconnect between the labor market and protections, which may not actually improve informal employment. It might also be possible to create other methods of generating income through microloans or land rights when access to the formal sector is limited. This is not a satisfactory solution to effectively combat the issues underlying the informal sector though.[16]

Informal Housing

The term informal housing can include any form of shelter or settlement (or lack thereof) which is illegal, falls outside of government control or regulation, or is not afforded protection by the state. To have informal housing status is to exist in ‘a state of deregulation, one where the ownership, use, and purpose of land cannot be fixed and mapped according to any prescribed set of regulations or the law.’[26] While there is no global unified law of property ownership[27] typically, the informal occupant or community will lack security of tenure, and with this ready or reliable access to civic amenities (potable water, electricity and gas supply, sanitation and waste collection). Due to the informal nature of occupancy, the state will typically be unable to extract rent or land taxes.

The term informal housing is useful in capturing informal populations other than those living slum settlements or shanty towns, which are defined more narrowly by the UN Habitat as ‘contiguous settlement where the inhabitants are characterizes as having inadequate housing and basic services..often more cake is needed but not recognised or addressed by the public authorities an integral or equal part of the city”.[28]

Common categories or terms for informal housing include slums, slum settlements, shanty towns, squats, homelessness and pavement dwellers.

Informal housing in developing countries

Homelessness and insecurity of tenure are issues faced by populations around the world. However, there are particularly pernicious circumstances in developing countries that lead to a large proportion of the population resorting to informal housing. According to Saskia Sassen, in the race to become a ‘global city’ (wiki ref) with the requisite state-of-the-art economic and regulatory platforms for handling the operations of international firms and markets’, radical physical interventions in the existing fabric of the city are often called for, displacing ‘modest, low-profit firms and households’.[29]

If these households lack the economic resilience to repurchase within the same area, or relocate to a place that offers similar economic opportunity, they are prime candidates for informal housing options. For example, in Mumbai, India, this fast-paced economic growth, coupled with inadequate infrastructure, endemic corruption and the legacy of the restrictive tenancy laws[30] have left the city unable to house the estimated 54% who now live informally.[31]

Many cities in the developing world are currently experiencing a rapid increase in informal housing, driven by mass migration to cities in search of employment, or fleeing from war or environmental disaster. According to Robert Neuwirth, already there are over 1 billion, or one in six squatters worldwide. If current trends continue, this will increase to 2 billion by 2030 (one in four), and 3 billion by 2050 (one in three).[32] Informal housing, and the often informal livelihoods that accompany them, are set to be defining features of the cities of the future.

See also

Sustainable development portal


Further reading

  • An article by a collaborator of de Soto.
  • A working paper describing attempts to formalize street vending in Mexico.
  • Community Links and Microfinance organisation Street UK providing analysis of the motivations of informal workers.
  • Community Links explores the experience of people on low incomes, doing informal paid work.
  • World Bank policy note on The Informality Trap: Tax Evasion, Finance, and Productivity in Brazil
  • World Bank policy note on Rising Informality - Reversing the Tide
  • Paper estimating the size of the informal economy in 110 developing, transition and developed countries
  • The link is to an online archive of Keith Hart's works.

benjamin temkin. "Informal Self-Employment in Developing Countries: Entrepreneurship or Survivalist Strategy? Some Implications for Public Policy" Analyses of Social Issues and Public Policy Vol. 9.No. 1 (2009)

External links

  • Co-chaired by de Soto and former secretary of state Madeleine Albright.
  • The Americas: Decent work - a rarity Independent news reports and features about the world of labour in the Americas by IPS Inter Press Service

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