Opportunities to Reduce Economic Informality

Introduction

Most of the world has an informal, or hidden, economy working in parallel to the formal, or mainstream, economy. The informal sector produces goods and services outside of government regulation and without legal status or protection. It consists of all firms, labor, and activities that are not legally recognized, not officially recorded, and not embedded in the modern market economy. 

A common feature of developing and even developed economies, informality raises consequential dilemmas. Entrepreneurs in the sector generally produce legitimate goods and services, yet do not enjoy legal status. The sector provides avenues for earning a livelihood that may not exist in the formal sector, yet it lacks social protections and inhibits growth. It exists outside the system of public institutions, yet it effectively undermines the system. Those in the sector are generally at a disadvantage when it comes to accessing financing, markets, and services, yet still they pose unfair competition to their formal counterparts. 

In 1984 at the prompting of Hernando de Soto, the Center for International Private Enterprise (CIPE) began its search for solutions to transform informal entrepreneurship. De Soto, CIPE’s first program partner, had the insight that the quality of the business environment affects the level of entrepreneurial opportunity. Ever since, CIPE’s programs have addressed issues of institutional quality and the incentives and barriers to doing business. Today, the persistence of massive informality is closely associated with disparities in society and the disenfranchisement of many. Fortunately, policymakers and practitioners now possess a broad range of experience and tools to help deal with the challenge. 

This issue brief presents methods to expand entrepreneurial opportunity while strengthening the rule of law. It offers guidance to all who seek a competitive business environment, a more inclusive economy, or private sector development in harmony with the provision of public goods. It is aimed at policymakers, business leaders, and advocates for the informal sector. Following an overview of economic informality, the brief shares lessons from past policies, steps to tailor a reform strategy, and promising options for targeted solutions. Five miniature country case studies illustrate progress and lessons from reforms to taxation, registration, inspections, and more.