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labor markets, which may bear the brunt of adjustment during business cycles (Guriev, Speciale, and Tuccio 2019; Meghir, Narita, and Robin 2015). The following section discusses how informality is defined and describes various measures of informality. Then, the chapter documents the main features of the informal economy across EMDE regions and the main similarities and differences across various measures of informality. Next, it documents informal-economy business cycles, followed by concluding remarks.
Definition of informality Informality is typically defined as market-based and legal production of goods and services that is hidden from public authorities for monetary, regulatory, or institutional reasons (Schneider, Buehn, and Montenegro 2010). Monetary reasons include the avoidance of taxes and social security contributions, regulatory reasons include the avoidance of government bureaucracy or regulatory burdens, and institutional reasons include corruption, related often to the poor quality of political institutions and weak rule of law. These factors affect firms’ and workers’ decisions to participate in the formal sector (Perry et al. 2007; Ulyssea 2020). For the purposes of this book, the informal economy involves activities that, if recorded, would contribute to GDP, and does not cover illegal activities or household production (Medina and Schneider 2018; Schneider, Buehn, and Montenegro 2010). This section summarizes the definitions and classifications of informality used by previous studies. Motivations for informal economic activity. The definition and classification of informality are highly context-specific. Similarly, the choice of informality measures will depend on the question being explored. The general definition referred to above encompasses many types of informal activities by workers and firms. •
Exit versus exclusion. Some workers and firms are “excluded” from the modern economy or from state benefit systems because of burdensome entry regulations and lack of human capital (de Soto 1989; Loayza, Oviedo, and Servén 2006; Perry et al. 2007). This type of informality is frequently associated with low productivity and with poorly paid and low-skilled employment (La Porta and Shleifer 2014; Loayza 2018). Other informal workers voluntarily “exit” the formal sector and choose informal activity for its flexibility, independence, and lower regulatory compliance burdens (figure 2.1; Blanchflower, Oswald, and Stutzer 2001; Falco and Haywood 2016; Günther and Launov 2012; Maloney 2004). Both “excluded” and “exiting” types of informality could coexist in an economy (Bosch and Maloney 2008, 2010; Lehmann and Pignatti 2007; Nordman, Rakotomanana, and Roubaud 2016).
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Subsistence informality. Other studies focus on “subsistence informality,” which is pervasive in lower-income countries and characterized by low-skilled technology and the fact that, in the absence of such informal economic activity, the incomes of the workers involved would fall below subsistence levels (Docquier, Müller, and Naval 2017).
