Marginalized Informal Economies

The informal economy consists of business activity that is neither reported to the government nor subject to government restrictions or regulations. Thus, the money value of goods or services produced by firms in the informal economy is not included in national economic aggregates such as GDP or GNI. The informal economy is known by many names such as underground economy, shadow economy, gray economy, and informal sector. The International Labor Organization (ILO), an agency within the United Nations System, has identified two main components of the informal economy — informal business enterprises and informal employment.^[1] The data collected by most multilateral organizations on the informal economy consider only licit business activity and exclude criminal activities such as drug trafficking and smuggling. In the formal economy businesses and workers report business activities, pay taxes, and comply with business regulations or other requirements. These business activities are reported in national data aggregates.

The structure of business enterprises in the informal economy is diverse. One type of business organization is the own-account enterprise, which is owned and operated by self-employed entrepreneurs such as street vendors or domestic workers. A second type of business organization is the microenterprise, which is a small firm that typically employs several laborers at jobs in auto repair, small-scale construction, or other niche occupations. A third type of business organization is the established business that conducts a portion of its business in the formal sector of the economy and a portion “off the books” in the informal economy. In each type of business organization, businesses and workers intentionally avoid reporting output, employment status, wages, and other aspects of production to circumvent taxes and government regulations.^[2]

Informal economies operate beneath the layer of formal reported business activity in all countries. The largest informal economies are found in the developing and emerging market economies. The smallest informal economies appear in the advanced economies. A recent study quantified the size of informal economies in 162 countries by estimating the value of unreported business activity as a percent of gross domestic product (GDP) in each country. This study concluded that the largest informal economies existed in three world regions: Latin America and the Caribbean, Sub-Saharan Africa, and Europe and Central Asia, as shown in Table 13.8.^[3]

The study also noted a tremendous variation of informal business activity within each world region. In Latin America and the Caribbean, for example, informal sector activity accounted for more than 60 percent of all business activity in Peru and Bolivia but only about 20 percent of business activity in Chile. Similarly, within the high-income OECD countries, the size of the informal economy in Mexico (31.4 percent of GDP) was more than three times that of the United States (8.7 percent of GDP).^[4] Key factors that increase

Table 13.8 Informal Economies by World Region

Source: Friedrich Schneider et al., Shadow Economies All over the World, 33.

Women sell produce at a market in Gualeceo, Ecuador. The majority of Ecuadorians are mestizo, a Spanish term meaning mixed Spanish and Amerindian ancestry.

informal sector business activity include high business taxes, stifling business regulations, low worker education and skills, and dire poverty. Factors that reduce informal sector business activity include high national income, universal public education, good governance and the rule of law, and property rights.

The size and importance of informal economies around the world have forced economists and policy makers to assess the benefits and costs of the extralegal sector in economies. Experts generally conclude that the existence of informal economies stimulates entrepreneurial activity, business formation, and jobs creation. In fact, the ILO recently reported that between half and three-quarters of all nonagricultural jobs in the developing countries were in the informal sector. One of the main costs of informal economies is the lack of regulatory protections for workers, especially the unskilled, migrants, women, and other vulnerable groups. Sweatshop working conditions, low pay, and irregular work shifts in the informal sector violate ILO mandates for “decent work.” Further, unreported business activity deprives countries of tax revenues that are needed to support key social services.^[5]

The merger of the informal and formal sectors of developing economies is viewed as an important development goal by some economists, including noted Peruvian development economist Hernando de Soto. To achieve this goal De Soto favors the extension of private property rights and business rights to the poor. He argues that under existing rules and regulations the poor are denied access to credit and legal standing for their businesses. Thus, the extralegal productive assets of the poor represent trillions of dollars in “dead capital” in the global economy. Dead capital consists of assets in the informal sector that cannot be used as collateral to gain credit or otherwise be woven into the formal economy.^[6] De Soto makes the case for the inclusion of all businesses into the formal economy.^[7]

PRIMARY DOCUMENT: Hernando de Soto Proposes an Extension of Property Rights to the Poor

Imagine a country where the law that governs property rights is so deficient that nobody can easily identify who owns what, addresses cannot be systematically verified, and people cannot be made to pay their debts. Consider not being able to use your own house or business to guarantee credit. Imagine a property system where you can’t divide your ownership in a business into shares that investors can buy, or where descriptions of assets are not standardized.

Welcome to life in the developing world, home to five-sixths of the world’s population. Their plight underlines a paradoxical reality: capitalism is seen by the West as the answer to global underdevelopment, but it hasn’t even been tried because in a capitalist economy, all business deals are based on the rules of property and transactions which do not even exist in the Third World. Their property systems exclude the assets and transactions of 80% of the population, cutting off the poor from the global capitalist economy as markedly as apartheid once separated black and white South Africans. . . .

For poor countries to develop, the poor and lower middle classes must be allowed to use their assets in the same way that wealthier citizens do and the political challenge is to bring those assets from the “extralegal” sector into a more inclusive legal property system. There they can becomemore productive and generate capital for their owners, growth for the nation, and markets for industry.

“The Hidden Architecture of Capital,” Hernando de Soto

• [1] International Labor Organization (ILO), Statistical Update on Employment in the Informal Economy (Geneva: ILO Department of Statistics, June 2011), 1–2.
• [2] ILO, “Informal Economy,”; World Bank Group, “Concept of Informal Sector,”
• [3] Friedrich Schneider, Andreas Buehn, and Claudio E. Montenegro, “Table 3.3.4: Ranking of 25 OECD Countries According to Size of the Shadow Economy,” “Table 3.3.8: Average Informality by World Bank’s Regions,” Shadow Economies All over the World: New Estimates for 162 Countries from 1999 to 2007 (Washington, DC: World Bank, July 2010), 25, 33.
• [4] Ibid.
• [5] ILO, “Informal Economy,”; ILO, Decent Work and the Informal Economy, Report VI (Geneva: International Labor Office, 2002), 2-4; World Bank Group, “Concept of Informal Sector,”
• [6] Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000), Chapter 3.
• [7] Hernando de Soto, “The Hidden Architecture of Capital,” Institute for Liberty and Democracy, 2001