The Informal Sector

	Hari Srinivas
	Policy Analysis Series C-059

Abstract: The informal economic sector, often referred to as the "shadow" or "underground" economy, represents a significant and complex aspect of many nations' economies worldwide. This sector comprises a wide range of activities, from street vending and unregistered small businesses to casual labor and domestic work. Despite its informality, the sector plays a crucial role in providing employment opportunities, contributing to economic growth, and serving as a safety net for marginalized populations. However, it also faces numerous challenges, such as lack of legal recognition, limited access to financial services, and vulnerability to exploitation. Governments and policymakers globally recognize the need to address these challenges and facilitate the integration of the informal sector into the formal economy to harness its potential for inclusive economic development. Keywords: informal economy, formalization, access to finance, informal sector policies, social protection, regulatory framework, informal sector integration, development strategies

The endeavor to improve the informal economic sector involves a multifaceted approach encompassing various strategies and policies. It necessitates finding a balance between formalization, which can bring legal recognition and benefits, and preserving the flexibility and low entry barriers that attract individuals to informal activities.

Policymakers have identified ten key points to guide their efforts in this regard. These points span from encouraging formalization and enhancing access to finance to providing education and training for informal workers and creating supportive regulatory frameworks. Together, these strategies aim to empower informal entrepreneurs, reduce their vulnerabilities, and enable them to participate more fully in the broader economy.

Facts and Figures Facts and Figures on the Informal Sector Over 60% of the world's employed population (about 2 billion people) earn their livelihoods in the informal sector. (Source: ILO, 2018) 90% of employment in low-income countries and 67% in middle-income countries is informal. (Source: World Bank) In Sub-Saharan Africa, over 85% of workers operate in informal employment. (Source: ILOSTAT) In South Asia, the informal sector accounts for around 80% of total employment, with higher rates among women. (Source: ILO, WIEGO) Women and youth are disproportionately represented in the informal economy, often in low-paid, insecure jobs without social protections. Informal enterprises often contribute over 30% of GDP in emerging economies, despite being largely outside tax and regulatory systems. (Source: IMF estimates) Only 16% of informal workers worldwide have access to social protection or safety nets. (Source: ILO, 2021) More than 60% of informal businesses lack access to formal financial services, such as credit, insurance, or savings accounts. (Source: World Bank Global Findex Database) In urban areas, informal activities such as street vending, domestic work, and transport services are often critical to the functioning of the local economy. During COVID-19, informal workers lost 60% of their income in the first month of the pandemic, highlighting their vulnerability. (Source: ILO Monitor: COVID-19 and the world of work, 2020)

Governments around the world have recognized the importance of addressing the informal sector's challenges and have implemented a range of policies and initiatives aimed at supporting its growth and integration into the formal economy. These policies are not only crucial for economic development but also for social inclusion and poverty reduction.

By examining real-world examples of how governments have tackled these issues, we can gain valuable insights into the practical application of the ten strategies outlined for improving the informal economic sector. These efforts reflect the ongoing global commitment to harness the potential of the informal sector while mitigating its associated risks and vulnerabilities.

Figure 1: Policy options to make the informal sector inclusive

Improving the informal economic sector involves addressing the challenges and providing support to promote its growth and integration into the formal economy. There are a number of strategies adopted for this purpose.

As illustrated in Figure 1, there are 10 policy options to move the informal sector from informality to inclusivity. They are:

1. Formalization
2. Access to finance
3. Education and training
4. Infrastructure and basic services
5. Social protection
6. Regulatory framework
7. Market access
8. Technology adoption
9. Collaboration and partnerships
10. Data collection and research

The 10 criteria are explored in detail with examples below:

1	Formalization

Encourage and facilitate the formalization of informal businesses. This can be done through simplified registration processes, reduced bureaucracy, and offering incentives such as tax breaks or access to financial services. Policy steps that can be taken include: Implement a streamlined registration process for informal businesses, offering a one-stop online registration portal and a tax incentive program for those transitioning to the formal economy.

India's "Make in India" campaign aimed to simplify business registration processes and reduce bureaucratic hurdles for small and informal businesses. The initiative introduced streamlined regulatory procedures and encouraged state governments to establish single-window clearance systems. This made it easier for informal enterprises to register and access formal sector benefits, fostering a more business-friendly environment.

Peru's "CRECER" program supported the formalization of micro and small enterprises through simplified registration and technical assistance. The initiative provided informal entrepreneurs with legal advisory services, access to simplified tax regimes, and support in registering their businesses. By reducing administrative barriers and offering tailored support, the program successfully encouraged many informal enterprises to transition into the formal economy.

2	Access to finance

Enhance access to credit and financial services for informal businesses. This can be achieved through microfinance initiatives, creating specialized loan programs, or establishing partnerships with financial institutions to develop tailored financial products for informal entrepreneurs.

Policy steps that can be taken include Establish a government-backed microfinance institution that provides low-interest loans to informal businesses and collaborates with commercial banks to create specialized credit lines for micro-entrepreneurs.

Bangladesh's Grameen Bank pioneered microfinance initiatives, providing small loans to millions of informal entrepreneurs. It offered collateral-free loans to the rural poor, particularly women, enabling them to start or expand small-scale income-generating activities. This model demonstrated how access to credit could empower marginalized groups and drive grassroots economic development.

In Kenya, the M-Shwari mobile banking service offers easy access to savings and credit products to informal sector workers. Through a partnership between Safaricom and the Commercial Bank of Africa, M-Shwari allows users to save and borrow money using their mobile phones. This innovative solution has enabled financial inclusion for millions of Kenyans who lack access to traditional banking services.

3	Education and training

Provide training and capacity-building programs to improve the skills and knowledge of informal workers. This can include business management, financial literacy, marketing, and other relevant skills to enhance their productivity and competitiveness.

Policy steps that can be taken include Launch a national training program that offers free online courses in business management, financial literacy, and marketing for informal workers, with certification recognized by formal sector employers.

Brazil's National Service for Industrial Learning (SENAI) offers vocational training programs for informal workers, enhancing their skills. These programs include technical education, entrepreneurship training, and certification, equipping informal workers with tools to improve productivity and seek formal employment. SENAI has played a key role in bridging the skills gap for Brazil's informal workforce.

The Ghanaian government partnered with NGOs to provide training in financial literacy and entrepreneurship to informal sector workers. Workshops and community outreach programs were conducted to help workers manage their finances, maintain records, and develop sustainable business practices. These efforts have increased awareness and improved business outcomes among informal entrepreneurs.

4	Infrastructure and basic services

Invest in infrastructure development, including access to reliable utilities, transportation, and communication networks. Improving infrastructure can reduce costs, enhance productivity, and attract more informal businesses to formalize.

Policy steps that can be taken include Invest in building affordable co-working spaces and industrial zones with reliable utilities in areas heavily populated by informal businesses to reduce operating costs and encourage formalization.

In Egypt, the "Decent Life" initiative focuses on improving infrastructure and services in marginalized areas, benefiting informal businesses. The program invests in road development, water supply, sanitation, and electricity, particularly in rural and underserved communities. These improvements have lowered costs and increased operational efficiency for informal businesses in targeted regions.

Indonesia has invested in upgrading transportation networks to better connect informal businesses to markets. Efforts include building new roads and improving public transit, allowing small vendors and informal traders easier access to urban centers and customers. This has supported the expansion of informal enterprises and reduced logistical challenges.

5	Social protection

Implement social safety nets and social security systems to protect informal workers and their families. This can include healthcare, retirement plans, and other forms of social protection to provide a safety net and reduce vulnerability. Policy steps that can be taken include Introduce a comprehensive social security scheme that covers informal workers, providing access to healthcare, retirement benefits, and unemployment insurance through a subsidized contribution system.

Brazil's Bolsa Familia program provides cash transfers to low-income families, including many in the informal sector. The program offers financial aid conditional on education and health checkups, providing a safety net that helps stabilize household income. Many informal workers rely on Bolsa Fam?lia to reduce vulnerability during times of economic hardship.

South Africa's Unemployment Insurance Fund covers informal workers for certain benefits. Through voluntary registration, some categories of informal workers are now eligible for limited unemployment, maternity, and illness benefits. This inclusion marks a significant step toward extending social protections to the informal workforce.

6	Regulatory framework

Review and adapt regulatory frameworks to accommodate the needs and characteristics of informal businesses. This may involve creating flexible regulations that consider the unique nature of informal activities while ensuring basic standards of safety, quality, and fair competition.

Policy steps that can be taken include Develop adaptive regulations that classify and oversee informal businesses based on their size and impact, allowing for graduated compliance requirements to ensure safety and quality while minimizing bureaucratic hurdles.

Peru's "Regulation Simplification" initiative aimed to reduce red tape and simplify regulations for informal businesses. The government created a framework for easy compliance, particularly for micro and small enterprises, to encourage their formalization. As a result, many informal businesses were able to operate with legal recognition and reduced bureaucratic burden.

Colombia has implemented flexible labor market regulations to accommodate the informal sector. Policies include temporary work contracts and simplified tax regimes that allow informal workers to gradually integrate into the formal economy. These measures aim to balance protection with flexibility to avoid pushing workers out of employment.

7	Market access

Facilitate market access for informal businesses by promoting linkages with formal enterprises, providing market information, and supporting networking opportunities. This can help informal entrepreneurs expand their customer base and enhance their market presence.

Policy steps that can be taken include Create a government-sponsored online marketplace that connects informal entrepreneurs with formal sector buyers, offering training in e-commerce and digital marketing to increase their online presence.

Uganda's "Buy Uganda, Build Uganda" policy encourages government agencies to prioritize purchasing from local and informal sector suppliers. By mandating procurement from domestic producers, the policy boosts demand for locally made goods, many of which are produced in the informal sector. This has enhanced visibility and income generation opportunities for small vendors.

Mexico's "Tianguis Digital" platform helps informal businesses expand their customer base by selling products online. The government-supported e-commerce portal provides informal entrepreneurs with training and access to digital markets. This initiative has allowed informal businesses to reach a wider audience and increase their competitiveness.

8	Technology adoption

Encourage the adoption of digital technologies and e-commerce platforms to enhance the efficiency and competitiveness of informal businesses. This can include providing training on digital skills, supporting the development of online marketplaces, and improving access to affordable technology.

Policy steps that can be taken include Launch a digital literacy campaign in partnership with tech companies, offering subsidized smartphones and internet access to informal workers, along with training in using digital tools for business operations.

Nigeria's "Digital Literacy for Job Creation" program provides training to informal entrepreneurs on using digital tools for business growth. The initiative includes workshops and courses on mobile banking, social media marketing, and digital bookkeeping. It aims to increase digital inclusion and help informal businesses become more efficient and scalable.

The Philippines has supported the development of e-commerce platforms to connect informal sellers with buyers. These platforms offer tools for listing products, receiving payments, and tracking orders, with government support for digital training. Informal entrepreneurs have leveraged these systems to grow their businesses and reach new markets.

9	Collaboration and partnerships

Foster partnerships between government agencies, non-governmental organizations, and the private sector to coordinate efforts and resources for supporting informal businesses. Collaboration can help leverage expertise, share best practices, and ensure a comprehensive approach to addressing the needs of the informal sector.

Policy steps that can be taken include Establish a National Informal Sector Development Council, consisting of representatives from government, NGOs, and private sector associations, to coordinate resources and expertise in supporting informal businesses.

The Philippines established the Micro, Small, and Medium Enterprise Development Council, fostering collaboration among government agencies, private sector stakeholders, and NGOs. The council coordinates policy planning, training programs, and financial support for MSMEs, including informal businesses. Its collaborative model ensures that diverse actors contribute to the development and sustainability of informal enterprises.

Kenya's Huduma Centers serve as one-stop shops where informal entrepreneurs can access government services and information. These centers provide business registration, licensing, and social services under one roof, streamlining interactions with government agencies. Informal workers benefit from easier access to essential services and information.

10	Data collection and research

Invest in data collection and research to better understand the dynamics and impact of the informal sector. This can inform policy decisions, facilitate evidence-based interventions, and improve the overall understanding of the sector's contribution to the economy.

Policy steps that can be taken include Fund research institutes to conduct regular surveys and studies on the informal sector's economic contribution and challenges, providing data-driven insights for policymaking and program development.

South Africa's National Income Dynamics Study collects data on informal employment and economic activities to inform policy decisions. The longitudinal study tracks income, employment, and household dynamics, helping policymakers design targeted programs for informal workers. It has become a key tool for evidence-based policymaking in the informal sector.

In Morocco, the High Commission for Planning conducts surveys and research on the informal sector to guide policy formulation. This includes periodic reports on employment, productivity, and sector trends, enabling better understanding and responsive governance. The data collected supports the design of initiatives aimed at formalizing and supporting the informal economy.

Moving towards inclusivity

The informal economic sector plays a vital and challenging role in many nations' economies. It encompasses diverse activities such as street vending, unregistered businesses, and casual labor. While it offers employment opportunities and supports economic growth, it lacks legal recognition and financial access, leaving workers vulnerable to exploitation.

Globally, governments and policymakers acknowledge the importance to take steps towards integrating the informal sector into the formal economy. To achieve this, they have employed a multifaceted approach, striking a balance between formalization and maintaining the sector's flexibility and innate advantages.

Key strategies encompass formalization, enhanced financial access, education and training, infrastructure development, social protection, adaptive regulations, market access, technology adoption, collaboration, and data collection. These strategies aim to empower informal entrepreneurs, reduce vulnerabilities, and promote inclusive economic development and social inclusion.

Governments worldwide have struggled to address the challenges faced by the informal sector and implementing policies that support its growth and integration into the formal economy. These policies are not only vital for economic development but also for reducing poverty and ensuring social inclusion. Real-world examples of such efforts provide valuable insights into the practical application of the ten strategies outlined for improving the informal economic sector. There is a clear need for entities in the public and private sector to harness the informal sector's potential while mitigating associated risks and vulnerabilities to contribute to a more inclusive and prosperous local economy.

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