Case Study (EBM3083)
Case Study – The Informal Economy
The informal economy refers to commercial activities that occur at least partly outside a
governing body’s observation, taxation, and regulation. In slightly different words, sociologists
Manuel Castells and Alejandro Portes suggest that the “informal economy is characterised by
one central feature: it is unregulated by the institutions of society in a legal and social
environment in which similar activities are regulated.” Firms located in the informal economy
are typically thought of as businesses that are unregistered but that are producing and selling
legal products (that is, they sell many of the same products you might buy in legal businesses
but perhaps cheaper because they do not pay government fees and taxes). In contrast to the
informal economy, the formal economy is comprised of commercial activities that a governing
body taxes and monitors for society’s benefit and whose outputs are included in a country’s
gross domestic product.
For some, working in the informal economy is a choice, such as is the case when individuals
decide to supplement the income they are earning through employment in the formal economy
with a second job in the informal economy. However, for most people working in the informal
economy is a necessity rather than a choice—a reality that contributes to the informal
economy’s size and significance. Although generalising about the quality of informal
employment is difficult, evidence suggests that it typically means poor employment conditions
and greater poverty for workers. Estimates of the informal economy’s size across countries
and regions vary. In developing countries, the informal economy accounts for as much as
three-quarters of all non-agricultural employment, and perhaps as much as 90 percent in some
countries in South Asia and sub-Saharan Africa. But the informal economy is also prominent
in developed countries such as Finland, Germany, and France (where the informaleconomy is
estimated to account for 18.3 percent, 16.3 percent, and 15.3 percent, respectively, of these
nations’ total economic activity). In the United States, recent estimatesare that the informal
economy is now generating as much as $2 trillion in economic activity on an annual basis.
This is double the size of the U.S. informal economy in 2009. In terms ofthe number of people
working in an informal economy, it is suggested that “India’s informal economy … (includes)
hundreds of millions of shopkeepers, farmers, construction workers, taxi drivers, street
vendors, rag pickers, tailors, repairmen, middlemen, black marketers, andmore.”
There are various causes of the informal economy’s growth, including an inability of a nation’s
economic environment to create a significant number of jobs relative to available workers.
This has been a particularly acute problem during the recent global recession. In the words of
a person living in Spain: “Without the underground (informal) economy, we would be in a
situation of probably violent social unrest.” Governments’ inability to facilitate growth efforts
in their nation’s economic environment is another issue. In this regard, another Spanish citizen
suggests that “what the government should focus on is reforming the formal economy to make
it more efficient and competitive.” In a general sense, the informal economy yields threats
and opportunities for formal economy firms.
One threat is that informal businesses may have a cost advantage when competing against
formal economy firms because they do not pay taxes or incur the costs of regulations. But the
informal economy surfaces opportunities as well. For example, formal-economy firms can try
to understand the needs of customers that informal- economy firms are satisfying and then
find ways to better meet their needs. Another valuable opportunity is to attract some of the
Case Study – The Informal Economy
The informal economy refers to commercial activities that occur at least partly outside a
governing body’s observation, taxation, and regulation. In slightly different words, sociologists
Manuel Castells and Alejandro Portes suggest that the “informal economy is characterised by
one central feature: it is unregulated by the institutions of society in a legal and social
environment in which similar activities are regulated.” Firms located in the informal economy
are typically thought of as businesses that are unregistered but that are producing and selling
legal products (that is, they sell many of the same products you might buy in legal businesses
but perhaps cheaper because they do not pay government fees and taxes). In contrast to the
informal economy, the formal economy is comprised of commercial activities that a governing
body taxes and monitors for society’s benefit and whose outputs are included in a country’s
gross domestic product.
For some, working in the informal economy is a choice, such as is the case when individuals
decide to supplement the income they are earning through employment in the formal economy
with a second job in the informal economy. However, for most people working in the informal
economy is a necessity rather than a choice—a reality that contributes to the informal
economy’s size and significance. Although generalising about the quality of informal
employment is difficult, evidence suggests that it typically means poor employment conditions
and greater poverty for workers. Estimates of the informal economy’s size across countries
and regions vary. In developing countries, the informal economy accounts for as much as
three-quarters of all non-agricultural employment, and perhaps as much as 90 percent in some
countries in South Asia and sub-Saharan Africa. But the informal economy is also prominent
in developed countries such as Finland, Germany, and France (where the informaleconomy is
estimated to account for 18.3 percent, 16.3 percent, and 15.3 percent, respectively, of these
nations’ total economic activity). In the United States, recent estimatesare that the informal
economy is now generating as much as $2 trillion in economic activity on an annual basis.
This is double the size of the U.S. informal economy in 2009. In terms ofthe number of people
working in an informal economy, it is suggested that “India’s informal economy … (includes)
hundreds of millions of shopkeepers, farmers, construction workers, taxi drivers, street
vendors, rag pickers, tailors, repairmen, middlemen, black marketers, andmore.”
There are various causes of the informal economy’s growth, including an inability of a nation’s
economic environment to create a significant number of jobs relative to available workers.
This has been a particularly acute problem during the recent global recession. In the words of
a person living in Spain: “Without the underground (informal) economy, we would be in a
situation of probably violent social unrest.” Governments’ inability to facilitate growth efforts
in their nation’s economic environment is another issue. In this regard, another Spanish citizen
suggests that “what the government should focus on is reforming the formal economy to make
it more efficient and competitive.” In a general sense, the informal economy yields threats
and opportunities for formal economy firms.
One threat is that informal businesses may have a cost advantage when competing against
formal economy firms because they do not pay taxes or incur the costs of regulations. But the
informal economy surfaces opportunities as well. For example, formal-economy firms can try
to understand the needs of customers that informal- economy firms are satisfying and then
find ways to better meet their needs. Another valuable opportunity is to attract some of the
