Labor Formalization: The Road to Recovery

Informal workers make up a significant amount of the global employed population—more than 60%, to be exact. Those who work in the ‘shadow’ economy do so outside of government regulation, taxation and, most importantly, protection.While there’s been a push towards formalization in recent years, the COVID-19 pandemic has added an element of urgency when it comes to the informal sector—particularly in countries with vulnerable economies and populations.Latin America is one region that not only has high rates of informality, but could also stand to gain the most from more formal workers—with possible benefits extending to both the countries, the workers themselves, and the global economy as a whole.

Slow to Grow

Compared to other emerging regions, particularly those in Asia, Latin America has been burdened by low and unevenly distributed economic growth—averaging around 2-3% in the region.While there are many factors involved, high informality rates play a large role.

In the region, growing informality rates are associated with decreased productivity, along with capital and labor that are stuck in inefficient activities.Rigid labor regulation plays a role in this phenomenon, which is rampant in the Latin America and the Caribbean (LAC) region. Roughly half of the region’s population is involved in informal work, much the result of regulation.Regulatory rigidity impacts the labor market in several ways:

• High redundancy costs (especially compared to other emerging markets)
• Complex approval processes for employee dismissal
• Requirement of permanent contracts in many countries
• Higher minimum wage to asset value (when compared to other emerging markets)

While these factors mean that employers and companies are less likely to formalize, they do pave a path towards formalization, and subsequent efforts have proven successful.

An informal vendor sells fruit on the streets of Lima.

In Mexico, for instance, a 2012 reform on firing and hiring costs led to an increase in formal, salaried jobs.Over the past decade, Uruguay has seen a significant drop in labor informality. This is in part due to collective bargaining negotiations, and a tax reform that incentivized job creation.Similar trends have been experienced in other Latin American countries, and while beneficial to the countries themselves, the link between formalization and reduced inequality provides another motive for formalization in the labor market.

Social Sustainability and Labor Formalization

According to a Vanderbilt University report, participation in informal work means “low and precarious incomes with minimal social protections, it prevents the poor from accessing sorely needed loans and savings instruments, and it diminishes overall societal prosperity by proliferating economic inefficiency.” These conditions affect hundreds of thousands of workers across Latin America.For countries like Colombia, Honduras, Nicaragua, and Ecuador, all of which suffer from high levels of informality (around 60 to 80%), formalization can have a significant impact on social sustainability.

Many social inequalities were either brought to light—or worse, exacerbated—by the global pandemic, which has led to efforts “towards a more formal ‘new normal.’”With a vulnerable workforce that has minimal access to social protection, there’s a stronger impetus than ever towards formality—and the workers have taken center stage behind recent efforts.

A man sells goods mid-traffic in Sao Paolo.

There are links between both the Sustainable Development Goals (SDGs) and Environmental, Social, and Governance investments that put decent work and productive employment at the forefront of inclusive and sustainable economic growth.Responsible investment in the Latin American region has really taken off over the past few years and recovery from the COVID pandemic provides an opportunity to generate formal employment and contribute to sustainable development.And this comes at a time when sustainable development is absolutely critical.[caption id="attachment_12530" align="aligncenter" width="300"]

http://www.lacea.org/vox/?q=blog/informality_latam_postcovid19[/caption]In many LAC countries, gains made over the past couple of decades with regard to poverty levels and inequality are at risk of being wiped away.While some countries, Colombia for instance, saw both a decline in unemployment and a moderate rise in GDP in 2020, an integrated approach to continue formalizing the workforce is essential to support a socially sustainable future.In other areas of the world, where the effects of the pandemic have slightly subsided, many recovery plans encompass sustainability and social elements, like in the European Union—where clean energy infrastructure and education have been incorporated into efforts.In LAC, the generation of formal jobs and formalization of those already in existence can contribute to recent efforts aimed at closing the output gap. An increase in formal workers can support economic growth, as well as sustained positive social and environmental outcomes.Countries committed to fostering a more formal labor sector in Latin America can harness the momentum brought on by the global crisis to benefit from systemic change that is long-lasting and impactful on many fronts.