Informality and economic correlates

interaction with the state by remaining informal (Choi and Thum 2005; Friedman et al. 2000; Sarte 2000).12 Governments may strategically design and implement systems of poor governance to promote informality for the poor as an alternative redistributive strategy (Marjit, Mukherjee, and Kolmar 2006). But poor governance stymies development.

Lack of resilience against the COVID-19 pandemic. The COVID-19 pandemic has exacerbated these development challenges (box 2.1). The global recession caused by the pandemic hit firms and workers in the informal sector particularly hard. Lockdowns have had a particularly disruptive effect on services activities involving human interaction, where informal firms are common, and have thus hit informal employment particularly hard. Large-scale fiscal support implemented in 2020 primarily targeted formal workers and formal firms, with limited support for informal workers or firms (chapter 2; World Bank 2020a). The unprecedented surge in unemployment caused by the global lockdown after the pandemic disproportionally affected jobs in low-valueadded services with a large presence of informal jobs (Al Masri, Flamini, and Toscani 2021). A portion of job losses in the service sector may be permanent (Autor and Reynolds 2020; Zenker and Kock 2020).

A large empirical literature has documented the links between informality and poor economic conditions. In particular, a large informal economy is associated with lower per capita incomes, greater poverty, less financial development, limited trade openness, and weaker output growth. These indicators differ significantly between EMDEs with high and low informality (figure 4.5).

Methodology. The next sections rely on a comprehensive literature review as well as several empirical approaches to identify and illustrate the main correlates of informality. The data are drawn from the database detailed in chapter 2 and include data for up to 160 EMDEs and 36 advanced economies for 1990-2018. First, a descriptive statistical approach is used. The sample of more than 122 EMDEs for 1990-2018 is split into those with above-median and below-median shares of informality by output (estimates based on dynamic general equilibrium [DGE] model) and by employment (proxied by self-employment shares, see table 4D.12; for other measures of informality, see table 4D.13). Average development outcomes for these two groups are then compared provided that differences between the two groups are statistically significant. In the following sections, results are obtained using output informality, unless otherwise specified. The findings are robust to using employment informality, to the use of alternative definitions of informality, or to using a regression that differentiates between quartiles of economies by informality (tables 4D.14-4D.15). These comparisons

12 In turn, widespread informality incentivizes government officials to impose excessive regulations that confers on them the power to collect bribes in return for providing permits (Shleifer and Vishny 1993).