Informality: Why is it so Widespread and How Can it Be Reduced?

Abstract

In a typical developing country, about 70 percent of workers and 30 percent of production are informal. Informality is a cause and a consequence of the lack of economic and institutional development. It implies productive inefficiency and a culture of evasion and noncompliance. Informality, however, exists because it offers the advantages of flexibility and employment in economies with low labor productivity and an excessive regulatory burden. Under these conditions, if there were no informality, there would be greater unemployment, poverty, and crime. A well-conceived formalization strategy should seek to make formality more attractive. As the causes of informality are complex and interrelated, the reforms to reduce it must include all relevant areas. A formalization strategy should consist of making labor markets flexible, reforming social protection, increasing labor productivity, making the regulatory framework and the justice system efficient, and rationalizing the tax system.

Keywords: Labor Markets, Social Protections & Assistance, Employment and Unemployment