Informal Economy Thrives in Cities

For many poor people in urban areas, the primary means of economic survival is the production or sale of goods or services through semi-legal or illegal ventures, known as the informal economy.1 Conservatively, informal employment accounts for half to three quarters of all nonagricultural employment in developing countries: 48 percent in North Africa, 51 percent in Latin America, 65 percent in Asia, and 72 percent in sub-Saharan Africa.2

In the 13 principal metropolitan areas of Bogotá, Colombia, 58.5 percent of workers are classified as informal.3 In Bolivia, the informal sector provides an estimated two thirds of the gross domestic product (GDP), and in Peru the figure is 58 percent.4 Because of the sheer number of workers, clients, budgets, and transactions involved in informal markets, legality is marginal; informality is the norm.5

The greatest increase in the informal economy since 1990 has occurred in sub-Saharan Africa, Latin America, and Central Asia— often accounting for more than 50 percent of GDP.6 (See Figure 1.) The last few years have seen a continuation of this trend, with Africa and Latin America having the highest levels of informality.7 In contrast, in Europe the growth of informality is slowing and even declining in the wake of extensive microeconomic reforms, while in East Asia, where firms face smaller regulatory and tax burdens, the informal economy remains stable at fairly low levels.8

The weight of such markets becomes clear when considering that economic power is concentrated in the cities. The purchases made by urbanites, who cannot live off the land, form the foundation of national economies.9 Although 60 percent of the labor force in India is in the agricultural sector, for instance, they produce only 20 percent of the GDP, while the 28 percent of the population working in services provide 61 percent.10

Several factors combine to create the unique yet common pattern of informal markets. First, exaggerated government intervention in civil society and economic activity often creates “hyper-bureaucratization” that deters citizens from pursuing a legal path.11 For example, it is virtually impossible for 90 percent of Tanzanians to enter the legal economy.12 A poor entrepreneur who obeyed the law would, over 50 years of business life, pay $91,000 to the national government for licenses, permits, and approvals and spend 1,118 days in government offices petitioning for them.13A private company can only be incorporated in Dar es Salaam and would cost nearly $2,700—almost four times the average annual wage of an ordinary Tanzanian. 14 Similarly, in Peru the constant increase in sales taxes—which went from 5 to 15 percent from 1978 to 1987 and today stand at 19 percent—favored expansion of the informal sector.15

Second, governments lack the resources to meet the demands of urbanization and enforce laws. Heavily indebted governments with limited tax collection and with convoluted and uninformed bureaucracies cannot provide adequate social expenditures.16 Rapid urbanization in developing countries has created pressures that have constrained the capacity of cities to provide adequate employment, waste disposal, water supply, food supplies, and housing.17 Urbanization itself has thus bred new types of economic arrangements and social conditions.

Third, as businesses are unable to create jobs as fast as demand increases, people must find a way to survive outside of regulated employment. 18 And fourth, many national and international companies prefer informal employment relations that allow them to be flexible during production cycles and that reduce labor costs.19

Thus it is not uncommon to visit an emerging market and perceive chaotic and unregulated yet bustling economies. Dharavi in India, the largest and most established of Mumbai’s slums, by one estimate houses up to 10,000 small factories, almost all of them illegal and unregulated.20 The factories provide an income for the approximately 1 million people who live in an area barely half the size of New York City’s Central Park.21 Although the concentration of businesses could easily deter consumers, the large scale at which informality occurs yields an estimated $665 million in annual revenue.22 On a national scale, in Haiti untitled rural and urban real estate holdings are together worth some $5.2 billion—four times the assets of all the legally operating companies in Haiti, nine times the assets owned by the government, and 158 times the value of all foreign direct investment in Haiti up through 1995.23

As the economic potential is great, the economic loss is equally substantial. Workers and enterprises receive little if any legal protection or worker benefits, they are the target of bribery, and they often face competitive disadvantages in terms of larger formal firms in capital and product markets.24 Variations in incomes are great: in Bolivia, the owner of a small informal business might have an average income 12 times the national minimum wage, while informally paid workers and domestic servants make around half the minimum wage.25

Furthermore, there are indirect costs to informality. The unsafe working conditions found in the unregulated businesses of Dharavi, India, for example, are common throughout the world. In dark unventilated foundries, workers ladle molten metal into a belt-buckle mold held between their bare feet.26 In another warehouse, men smeared from head to toe in blue ink strip the casings from used ballpoint pens so they can be melted down and recycled; few wear gloves or other protective gear, despite exposure to solvents and other chemicals.27 Environmental and health hazards are just one of the realities workers have to withstand to be able to produce with minimal resources.

The indirect costs also exact a hefty social price. Even though the informal market has local arrangements that help keep track of transactions, the legitimacy of these informal rights is still too locally politicized compared with those that are protected by national law.28 The inability to determine the rightful owner of resources creates or exacerbates conflicts throughout the world.29 In Bangalore, India, extortion exists even in hospitals: new mothers have their infants whisked away by an attendant who demands a bribe.30 If you want to see your child, families are told, the price is $12 for a boy and $7 for a girl.31 Such new “enterprises” are the result of a combination of a real need and a lack of regulation.

The lack of regulation distorts economic and social systems. With little or no unbiased and standardized regulation, most potential assets in emerging markets have not been identified or realized, there is little accessible capital, and economies are constrained and sluggish.32 It is not surprising, then, that extensive preliminary research shows that countries with a sophisticated legal and political system and stronger protection of physical and intellectual property rights experience higher economic well-being.33