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C H A P T ER 4
T H E L O NG S HA D O W O F I N F O R MA L I T Y
BOX 4.3 Informality, poverty, and income inequality
Economies with greater informality also feature more poverty and greater income inequality. The coincidence of informality, poverty, and income inequality partly reflects wage differentials between formal and informal employment and the presence in those emerging market and developing economies (EMDEs) where informality is more prevalent of weaker fiscal positions, social safety nets, and growth. Declines in informality have been associated with poverty reduction but not systematically with declines in income equality.
Introduction Prevalence of informality is associated with persistent poverty and income inequality. a This may reflect higher wages for formal than informal workers and more limited income redistribution in EMDEs with widespread informality. Limited redistribution, in turn, in part reflects a lack of fiscal resources, inefficient or inadequate tax and social security systems, burdensome regulations and taxation, and relatively slow economic growth.b The association with inequality has been noted especially in poorer countries (Dell’Anno 2016; Elgin and Elveren 2019), other researchers have found an association with increases in income inequality (for instance, Mishra and Ray 2010; Rosser, Rosser, and Ahmed 2000). c The COVID-19 (coronavirus) pandemic has led to an increase in global poverty for the first time in decades (World Bank 2020b, 2021). It has hit informal firms and informally employed workers particularly hard, in part because they struggled to adjust to digital operations and to access government support schemes (box 2.1; Yoshida, Narayan, and Wu 2020). Meanwhile, because of severe economic contractions in the formal sector, the share of informal activity is likely to have increased as a result of the pandemic. Against this backdrop, this box explores and quantifies the relationships between informality and poverty and income inequality by addressing the following questions: •
How strong is the association between informality and poverty or income inequality?
Note: This box was prepared by Sergiy Kasyanenko. a. For cross-country studies, see Devicienti, Groisman, and Poggi (2009); Fields and Pieters (2018); Gasparini and Tornaroli (2007); ILO (2018b); and World Bank (2019, 2020b). b. For studies showing the potneital channels via which informality is linked with limited redistribution, see Besley and Persson (2014), Ordóñez (2014), Perry et al. (2007), and World Bank (2019, 2020b). c. Country-level studies often find that higher informality is associated with greater income inequality (Amarante, Arim, and Yapor 2016; Ariza and Montes-Rojas 2017; Docquier and Iftikhar 2019).
