Informal Economy
The informal economy refers to economic activity that is not covered or is insufficiently covered by formal arrangements, including unregistered enterprises, undeclared work, and activities that fall outside the scope of official statistics and regulation. The informal economy is substantial in many developing countries and remains significant in some advanced economies. It provides livelihoods for a large share of the workforce, but it also creates challenges for taxation, regulation, and social protection.
Definition and measurement
The informal economy is defined differently across contexts. Broadly, it includes own-account workers and unincorporated enterprises that are not registered, employees without formal contracts or social protection, and activities that are hidden from official records. The statistical framework distinguishes employment in the informal sector, informal employment outside the informal sector, and the informal economy as a whole, which also encompasses production for own final use.
Measurement is difficult because informal activity is by definition unrecorded. Statistical agencies use household and labour force surveys, mixed surveys that combine enterprise and household information, and indirect methods that infer informal activity from discrepancies in national accounts and from indicators such as electricity consumption. Estimates are subject to considerable uncertainty.
Causes
The informal economy arises from several factors. High costs of registration, taxation, and compliance encourage firms and workers to remain informal. Weak enforcement and limited administrative capacity reduce the incentive to formalise. Labour market rigidities, such as high minimum wages and generous severance requirements, can push workers into informal arrangements. Migration, poverty, and limited access to education and credit also contribute.
Structural factors matter: economies with large agricultural sectors, low productivity, and weak institutions tend to have larger informal economies. In advanced economies, informal activity is often concentrated in services such as construction, hospitality, and domestic work, and in the gig economy, where platform work has created new forms of informal or semi-formal employment.
Consequences
The informal economy has mixed consequences. It provides income and flexibility for workers who might otherwise be unemployed, and it can support entrepreneurship and survival activities. However, informal workers typically lack social protection, are exposed to unsafe conditions, and earn less than formal employees. Informal firms face limited access to credit, markets, and public services, which constrains their growth and productivity.
For the broader economy, informality reduces the tax base and can undermine the financing of public goods. It can also distort competition, as informal firms may undercut formal ones by avoiding taxes and regulations, while formal firms bear the full cost of compliance. Informality can lower measured productivity and complicate the design of macroeconomic policy, since informal activity responds differently to interest rates and fiscal measures.
Policies and formalisation
Policies to address informality include simplifying registration and tax procedures, reducing compliance costs, extending social protection to informal workers, and strengthening enforcement. Some countries have introduced simplified regimes for small businesses that lower the cost of formalisation. Others have expanded contributory social insurance to self-employed and domestic workers.
The transition to formality is gradual and context-dependent. Evidence suggests that a combination of incentives, such as access to credit and social protection, and enforcement is more effective than either alone. Digital technologies, including mobile payments and e-government platforms, have reduced the cost of formalisation in many settings. Economic growth, structural transformation, and improvements in education also reduce informality over time.
Informality and gender
Informality has a strong gender dimension. Women are disproportionately represented in informal employment, particularly in domestic work, home-based production, and street vending, where they often lack contracts, social protection, and access to credit. These patterns reflect constraints on women's participation in formal employment, including care responsibilities, discrimination, and limited access to education and assets.
Policies to address informality therefore have gender implications. Extending social protection, improving access to childcare, and supporting women's entrepreneurship can reduce the gender gap in formal employment. Data collection that disaggregates informal employment by gender and activity helps to design targeted interventions and to monitor progress.
Informality and social protection
The link between informality and social protection is central to policy design. Contributory social insurance, financed by payroll taxes, covers formal employees but tends to exclude informal workers, who lack the employment relationship through which contributions are collected. Extending coverage requires either subsidising contributions for low-income workers or financing benefits from general revenue.
Non-contributory schemes, including universal or means-tested transfers and pensions, have expanded in many countries and can reach informal workers, but they raise questions about fiscal sustainability and about the incentive to formalise. Hybrid approaches combining contributory and non-contributory elements, with gradual vesting of entitlements, have been adopted in several countries to encourage formalisation while extending protection.
Technology and the future of work
Digital platforms have created new forms of work that are often classified as independent contracting, blurring the boundary between formal and informal employment. Platform workers may have flexibility but typically lack social insurance, income security, and collective representation. Their treatment under labour law is contested and varies across jurisdictions, with some countries reclassifying workers and others creating intermediate categories.
The growth of remote work and digital payments also affects informality in traditional sectors. Mobile payments can bring informal transactions into the formal financial system, improving traceability and access to credit, while raising questions about surveillance and data protection. How societies manage these changes will shape the size and character of the informal economy in the coming decades.