Informal Economy Research Paper Starter

Informal Economy

The term informal economy refer to every kind of training that happens "off the books." The jobs people work, the businesses that employ them, the goods and services they produce are not accounted for in official records and data— such economic activity is untaxed and unregulated. Large informal economies exist in developed and developing countries alike. Often, informal economies arise because they meet the needs that their formal counterparts cannot.

Keywords Formal Economy; Gross National Product (GNP); Kinship Bonds; Non-Market Exchange; Post-Fordism; Reciprocity; Self-Provisioning; Social Marginalization; Social Network; Structural Unemployment; Subcontracting; Tax Morale; Transfer Payments; Transaction Costs

Informal Economy


It has many names: the black market, the underground economy, the shadow economy. In size and earning power, the "informal" economy generates an estimated $10 trillion dollars annually. Huge amounts of money change hands clandestinely every day in developing, transitioning, and industrialized countries alike As anyone who has ever worked "off the books" knows, taxes are not paid on unreported. In addition, trillions of dollars exchanged in the illegal trade of drugs, weapons, and other goods is also untaxed.

The nexus of laws, law enforcement, and the social norms and values collectively known as "tax morale" varies considerably from country to country. And the more widely a government is perceived to be indifferent to, or incapable of, bettering the lives of its people, the lower the tax morale. The lists of grievances against many governments are long: overregulation, poorly conceived fiscal monetary and trade policies, corruption, and the systematic rollback of government benefit programs. All these grievances have the potential make the average citizen's life worse not better. He or she, then, may feel justified following the path of least resistance to the underground economy. At least in this position, it is still possible to eke out a subsistence living or earn a little extra.

In either case, the argument can be made that an informal economy rights some of the wrongs of the formal economy. Indeed, pioneering studies in Africa and Latin America in the 1970s and 1980s found that a vigorous entrepreneurship was notability absent in these economies-at-large. This may be so, considering the ease of market entry, the flexible staffing practices, the low-end wage structure, and the minimal transaction costs made possible by forgoing taxes, benefits, license fees and the investments necessary to meet workplace health and safety regulations. What is good for the underground entrepreneur, however, is not necessarily good for his or her employees. With no real job security or assured working hours, no health or retirement benefits, and for what is rarely more than a subsistence wage, the underground employee is expected to work long hours in often unsafe or unhealthy environments. Powerless and often desperately poor, he or she, critics charge, fast becomes just another exploited worker (Mollona, n.d.).

The problem, of course, is that the formal economy simply does not have enough jobs to go around. This situation has been made worse in industrialized countries by shrinking social-safety nets and in other countries by the absence of such programs all together. Simply put, the so-called "welfare" state is now considered too expensive to maintain much less expand. Tax revenues once earmarked for transfer payments and public sector services, the theory goes, are now better left to the citizenry to spend or invest in order to stimulate economic growth. In developing nations, the new economic credo simply re-enforces the existing goal of first developing the free-market private sector until a tax base large enough to afford major public spending on human services materializes. However, critics of this theory often point out that, once the tax base does develop, much of this newly generated wealth still ends up in the bank accounts of developing countries' elites, not welfare programs.

Further Insights

The Formal Economy vs. The Informal Economy

Since both the informal and formal economies function as full-fledged markets and both generate revenue and income, what differentiates the two? The only universally accepted distinction lies in the fact that governments know about and tax the one but not the other. All the other distinctions scholars make are subject to debate. Some experts, for example, believe petty and organized crime are part the informal economy. Others think black-and-white answers are too simplistic: what is "purchased" and how it is paid for, they caution, can determine whether the transaction is legal, quasi-legal or illegal. Complicating matters further, opinions vary on the related question of whether or not non-market exchanges of favors among members of a social network should be evaluated the same as unreported monetary or commodity (barter) exchanges. If they are, scholars wonder whether regular housework done by a family member should also be counted. (Henry, n.d.).

One of the first major researchers in the field, Alejandro Portes, defined the baseline difference between the two this way: in the formal economy, employment is predicated on a legally-binding contract that spells out the rights and responsibilities of all concerned whereas in the informal economy, it is not (Øyen, 2006). An omnibus model proposed in 1990 by P. H. Renooy drew a series of finer distinctions, most notably how the informal economy has lower barriers to entry, capital requirements, productivity, and prices. It is, however, far more flexible in its use of labor, so much so that its workers often must juggle several "invisible" jobs to make ends meet. Most of these jobs are secured through referrals from family and friends. Entrepreneurs face difficulties, too; they must overcome the localized, fragmented nature of the "black" market in order to expand their business. Information about pricing, competitors, new products, and trends in consumer demand are also far more blemished than they usually are in above-board marketplaces (Gërxhani, 2004).

No wonder, then, that few underground businesses successfully transition into the formal economy. This is not to say, however, that the two sectors never overlap. If anything, the dominant business model in this era of Post-Fordism has only served to blur the boundary-lines between them. Companies, in effect, no longer aspire to be the vertically integrated manufacturer of old. The surer route to profitability these days lies in being organizationally lean, turning out more targeted goods, and concentrating on core competencies to the exclusion of everything else (Roberts, n.d.).

Nimbler responses to changing market conditions are this era's mantra, and outsourcing its preferred way of doing business. All of this has been a boon to cost-conscious subcontractors who pay far less, offer no benefits, and hire temporary help on an as needed basis only. Conversely, it has also been a blow to unskilled and semi-skilled workers in industrial countries as their well-paid factory jobs have been moved offshore. Globalization in this respect is Post-Fordism writ large. To survive competitively, manufacturing companies must chase the lowest unit cost absolutely anywhere that takes them. (Fulcher & Scott, 2003).

Acting as extra-legal intermediaries, subcontractors facilitate the free-flow of commerce between the formal and informal economies. They do this by relieving clients of the administrative and regulatory burdens of maintaining a...

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