The informal economy: fact finding study

The informal economy: fact finding study

Causes of growth in the informal economy, who participates in it and why

This study provides an overview of the characteristics of the informal economy in developing countries, identifies reasons for the significance of the informal economy, and provides recommendations for SIDA on how to address the issues raised through its development programmes.

The paper emphasises that the informal economy needs to be better understood, by both governments and donors, because it has become apparent that it:

  • has a significant job and income generation potential
  • has significant linkages to the formal sector
  • is not merely a temporary phenomenon; although definitional and data collection problems make it difficult to gather accurate and internationally comparable information on the size and composition of the informal economy, survey-based estimates suggest that it is a significant and growing component of most developing economies. In Africa, for example, it is estimated that the informal economy provides 80% of jobs, and 90% of new jobs.

The report notes a number of causes for the continuing and growing importance of the informal economy. Overall, it suggests that the growth of the informal economy can often be traced to inappropriate, ineffective, misguided or badly implemented macroeconomic and social policies. First, growth in the informal economy is inverse to the growth of the formal economy; secondly, the informal economy is likely to be larger, and less likely to shrink with economic growth, where incomes and assets are not equitably distributed.

Reasons for increasing participation in the informal economy include:

  • insufficient job creation in the formal sector, due to either poor economic growth or jobless growth
  • barriers to entry to the formal sector, such as excessive taxation, regulation, government corruption
  • weak capability of formal institutions to provide education, training and infrastructure
  • redundancies arising from structural adjustment of the 1980s and 1990s
  • government neglect of the sector
  • disruptions such as migration and the HIV/AIDS pandemic
  • exclusion of women from property and land ownership.

The penultimate chapter provides an analysis of the informal economy as it relates to Sida’s development programme, and briefly discusses case studies from Nicaragua and Uganda.

The report advises that to reduce poverty and strengthen economic growth, policies are needed which recognise the importance of the informal economy, particularly increasing the productivity and improve the working conditions of those who work in it, and which also attempt to incorporate members of the informal economy into the formal sector. Currently, however, there appears to be a lack of agreement amongst donors on how to approach the informal economy, what the main problems are and how these could be resolved.

It recommends that donors address these issues through the use of policy dialogues, direct action programmes, focused research and statistics as well as empowerment of informal economy actors.

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