Informal Economy Thrives in Cities

Product Number: 
VST040

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

Notes: 
1. Martha Alter Chen, “Rethinking the Informal Economy:
Linkages with the Formal Economy and the
Formal Regulatory Environment,” EGDI and UNUWIDER,
April 2005, p. 11.
156 Vital Signs 2007–2008 www.worldwatch.org
Notes
2. Ibid., p. 13; “The Global Workforce: A Statistical
Picture,” Women in Informal Employment: Globalizing
and Organizing, at wiego.org/stat_picture.
3. “La Informalidad No Cede Terreno y Cobija a más
de la Mitad de los Trabajadores Colombianos,” El
Tiempo, 19 February 2007.
4. Norman V. Loayza, The Economics of the Informal
Sector: A Simple Model and Some Empirical Evidence
from Latin America (Washington, DC: World Bank,
1997), p. 47.
5. Hernando de Soto, The Mystery of Capital: Why Capitalism
Triumphs in the West and Fails Everywhere Else
(New York: Basic Books, 2000), p. 30.
6. Vincent Palmade and Andrea Anayiotos, “Rising
Informality,” Public Policy for the Private Sector, Note
No. 298, August 2005.
7. Friedrich Schneider, The Size of the Shadow
Economies of 145 Countries All Over the World: First
Results Over the Period 1999–2003 (Bonn, Germany:
Institute for the Study of Labor, December 2004).
8. Palmade and Anayiotos, op. cit. note 6.
9. Kai N. Lee, “An Urbanizing World,” in Worldwatch
Institute, State of The World 2007 (New York: W. W.
Norton & Company, 2007), p. 5.
10. Central Intelligence Agency, The World Factbook:
India, at www.cia.gov/cia/publications/factbook/
print/in.html.
11. Diego Palma, La Informalidad, Lo Popular y el Cambio
Social (Lima, Peru: Centro de Estudios y Promoción
del Desarrollo, 1987), pp. 17–18; de Soto, op. cit.
note 5.
12. Hernando de Soto and Francis Cheneval, eds., Realizing
Property Rights (Italy: Buffer&Rub, 2006), p. 21.
13. Ibid., p. 26.
14. Ibid., p. 51.
15. Carlos Ramon Ponze Monteza, Gamarra: Formación
Estructura y Perspectivas (Lima, Peru: Fundación
Friedrich Ebert, 1994), p. 66.
16. Palma, op. cit. note 11, p. 22.
17. Fernando Escalante Gonzalbo, “La Nueva Política,”
Cronica, 27 April 2005.
18. Lee, op. cit. note 9, p. 5.
19. Chen, op. cit. note 1, p. 19.
20. John Lancaster, “Next Stop, Squalor,” Smithsonian,
March 2007.
21. Ibid.
22. Ibid.
23. De Soto, op. cit. note 5, p. 33.
24. Chen, op. cit. note 1, p. 11.
25. Debraj Ray, Development Economics (Princeton, NJ:
Princeton University Press, 1998), p. 347.
26. Lancaster, op. cit. note 20.
27. Ibid.
28. De Soto, op. cit. note 5, p. 49.
29. Karol Boudreaux, “Property Rights and Resource
Conflict in the Sudan,” in de Soto and Cheneval,
op. cit. note 12, p . 72; Juan Pablo Viqueira, Encrucijadas
Chiapanecas (Mexico: Tusquets/COLMEX,
2002).
30. Celia W. Dugger, “In Bangalore, India, a Cuddle
with Your Baby Requires a Bribe,” New York Times,
30 August 2005.
31. Ibid.
32. De Soto, op. cit. note 5, p. 32.
33. Alexandra C. Horst, 2007 International Property
Rights Index (Washington, DC: Property Rights
Alliance, 2007), p. 32.