Article / October 8, 2020

Shining a Light on the Shadow Economy

The informal or ‘shadow’ economy exists in a grey area outside of government taxation, regulation, and protection.

Workers in the shadow economy often work on the fringes, and generally receive very low pay. Nonetheless, they’re vital to the global economy. 

These are the street vendors that provide meals for formal employees in major cities. They are the domestic workers who free up countless hours for working mothers. 

Or the moto-taxi driver in Thailand who brought me to the hospital when I nearly collapsed from dengue back in 2017. 

The informal economy supports every other industry, and they deserve all the rights reserved for registered workers. 

But before we start pounding the table about solutions, let’s look a bit closer at the situation.

Just how big is the informal labor market?

 

Hundreds of millions of people make up the informal labor market today. Two billion, as a rough estimate.

That’s more than 61% of the global population, far larger than the formal economy. 

Shadow workers represent a significant portion of the global economy. 

When looking at different sectors, informal labor accounts for nearly all of the agriculture sector in areas like the Asia Pacific. In European countries, 20 to 25% of the shadow economy connects to the tourism industry.

In Africa, the informal economy accounts for a staggering 85.8% of total employment.

On average, 93% of the world’s informal workers come from developing and emerging countries. It’s a labor force mostly made up of the world’s poorest people, and most of them work informally out of necessity. 

Formalizing the workforce can be synonymous with creating an opportunity for a tremendous number of people. 

That transformation couldn’t happen soon enough.

Shadow workers are critically at-risk…

 

During the COVID pandemic, over 1.6 billion workers in the informal economy are at risk of losing their livelihoods. There is a clear overlap with the informal economy and tourism, which collapsed during the pandemic.

When you consider there will be 1.14 billion fewer international arrivals in 2020 alone, it’s clear that the informal workforce will feel the pain for years to come.

The 2030 Agenda for Sustainable Development puts labor formalization front-and-center with Goal 8, which promotes…

“Sustained, inclusive, and sustainable economic growth, full and productive employment, and decent work for all.”

In fact, worker formalization in Latin America would lift approximately 40% of the workforce out of poverty.

And there’s more beneath the shadows than dodging taxes and bureaucracy:

Businesses operating outside the law propagate nasty business practices and inhumane activities. That negatively impacts not only informal laborers but their respective industries as a whole.

Not entirely unrelated, proliferate informal economies weaken the international trade performance of developing economies.

Large informal labor markets weaken international trade relationship. 

With the right governance, labor formalization has the clout to roll in significant positive changes. To name a few:

  • Higher quality, better paid, and more sustainable jobs.
  • Reinforced social contracts between citizens and the state.
  • More reliable agreements between firms.
  • Improved investor confidence (and thus, increased investment).
  • A broader tax base, which may allow for lower tax rates.
  • More robust data on local enterprises, allowing for better business and social contracts.
  • A reduced cash economy, providing more room for the formal financial sector to intermediate.
  • Improved access to business services, markets, and productive resources such as capital and land.
  • Increased welfare in marginalized populations.
What’s it take to ‘formalize’ the informal sector?

 

While the global economy is formalizing rapidly, the process isn’t easy and is prone to setbacks.

Policymakers and business analysts argue that labor formalization is mandatory for reducing poverty while also protecting the environment. However, formalization comes with a note of caution.

Informal workers in sectors with low earnings and high costs often don’t make enough money to meet the most basic tax thresholds. Aside from taxation, workers often do not see the incentive of regulation through licensing or certification. 

Licensing in many industries can take months or even years, an additional cost that most informal workers cannot afford.

While the details vary from case to case, every formalization success story shares a common feature: Incentives.

Workers need a package of incentives, including support and regulations that protect and empower them in ways they couldn’t attain informally.

The package may include training, micro-finance, or networking. Perhaps it requires a mix of all three. 

The solution is always contextual. What works for a gold miner in Ethiopia may not be appropriate for a street vendor in Thailand.

Success is possible…

 

The shadow economy could use some sunlight, and there’s precedent for positive change.

Brazil formalized about 5.5 million micro-businesses through incentives that include simpler taxes, social protection, business development services, and access to public markets.

Ethiopia formalized its gold mining sector using a basket of incentives for miners and gold traders, including training, micro-finance, and protective regulations. 

By 2016, more than 300,000 miners have organized into 600 cooperatives across the country. 

Cooperatives are imperative to formalizing shadow workers. It is far more difficult to achieve economies of scale, widespread training, and protections for vulnerable groups without them. 

Today more than 1 billion people work in cooperatives, and it’s a framework that has lifted millions out of poverty worldwide.

Ethiopia also benefited through economic improvements in auxiliary industries. Gold purchased by the National Bank of Ethiopia increased from 735kg in 2009 to 8386 kg in 2013.

Hundreds of workers at Colombia’s Palmas del Cesar have benefitted from an Agreement supported by the US Department of Labor and the International Labour Organization (ILO).

Previously outsourced, directly hired workers stand to gain job stability and the opportunity of protection through trade unions. 

“Labor formalization gives me the possibility to make dreams I’ve had for many years come true,” says José Guarín, president of a trade union for outsourced workers. “As of today, I can start to work on a life plan.”

A bit of formality can go a long way. If the trend continues, you’re likely to see more success stories just like these in the coming years. 

What about land formalization?

 

I’m glad you asked. We made a big deal out of that topic in a recent post:

[ Land Formalization: Colombia’s Road to Success ]

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