Informal Economy

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Informal Economy





All modern states regulate the economy; they also establish what goods and services are not, strictly speaking, part of this formal economy. Informal economy can refer to either or both of these residual spheres. It is therefore useful to discuss the term from the perspective of who uses it and with reference to what kind of society. For some economists a sphere such as the household-based family is not an economic sphere because no finite transactions can be observed therein. Sociologists, conversely, use the term to expose a broad array of unrecorded work. Thus, besides transactions unregulated by government, they include practices, such as housework, domestic consumption, and caregiving, that fall outside the economy as measured by gross domestic product.


Emphasizing the [low] degree of rationalization of working conditions, the anthropologist Keith Hart (2004, p. 8) first used the term informal economy in 1971 to describe the casual work of the poor in Accra, Ghana (Hart 1973; see also Geertz 1963). While Clifford Geertz and Hart worked from a Weberian understanding of economic rationality, the term informal sector was picked up by international agencies and development economists in terms of quantitative degrees of scale, productivity, and income. Because the term was used to replace earlier understandings of developing societies in terms of dual economies (Lewis 1955), its initial usage was confused. Thus relatively independent formal and informal sectors now replaced the older notion of modern and traditional sectors of a national economy in which market forces at work in the one were distorted by custom in the other. Development in both formulations was seen to occur as the more dynamic sector expanded to absorb ever larger swaths of the more backward one. The theoretical vagueness of the new term led to criticisms (Bromley and Gerry 1979) that, combined with the empirical failure of these prognoses, led to marginalization of the term until the dawn of the twenty-first century.

Twenty-first century analyses stress the crucial interplay between formal and informal economies in especially two ways. Firstly, there has been a general shift throughout market economies from formal institutions with sharply defined boundaries and functions to those with fuzzy boundaries and highly adaptable functions. As a result some writers prefer the notion informalization process rather than use of a set of criteria to distinguish two different spheres of a society (Castells and Portes 1989). Secondly, analysts have increasingly focused on the degree to which different components of the informal economy are crucially linked to the so-called formal economy through putting out to homeworkers and subcontracting to informal workshops, while other components remain relatively less directly linked (Chen 2005).

Interest in the informal economy is widespread among development practitioners and international and national-level policy makers as well as scholars in the various social sciences. Since it is inconceivable that there would be no informal practices in an economy or society, the way one understands such practices is likely to result from the kinds of settings on which one focuses. Among these are developing societies, socialist command regimes and their transformation, welfare regimes, and neoliberal regimes.


A primary concern in the literature on developing societies is whether or not the informal economy is a benefit or a handicap. Insofar as a low capital to labor ratio is almost a definitional feature, it can be argued that a large informal economy reduces a countrys average productivity; by avoiding start-up and running costs, it also effectively competes with firms paying taxes and legal fees. By contrast, insofar as it is, again almost by definition, the way poor people get by, the informal economy maximizes employment opportunities. In 2000 the Peruvian economist Hernando de Soto therefore advocated its encouragement through the introduction of a legal code more appropriate to current informal practices. His views, however, remain controversial.

Some commentators argue that these third world informal economies reflect a weak state that is unable to regulate uniformly throughout the polity. Prior to 1989 the reverse was the case for the informal economies that flourished under socialist command regimes, whose pervasive and rigid regulatory practices and intentional use of strategic scarcities provided the seedbed for informal practices. These eventually provided important networks that became the basis for resistance and eventual collapse of these regimes. The informal economy that resulted and now pervades the former Soviet bloc (Russia, Hungary, and so on) must be distinguished from socialist command economies that remain in place but have intentionally reduced the non-commodified socialist sphere. Here informal economy results from opening up ever larger areas of social interaction to market transactions that are nonetheless inconsistently regulatedChina being the most vivid example.

In the developed capitalist economies, interest in the growing size of the informal economy has frequently been attributed to the failures of welfare regimes either to be comprehensive in their provision of services or to stimulate economic dynamism. For some the state was not providing enough welfare, while for others what it did provide was too costly and too inflexible for the changing needs of capitalism. Thus one argument was that informal practices were taken on by people who were not being properly served by the welfare regime, partly as a result of declining formal jobs and partly as the welfare state failed to provide social citizenship to newly arrived immigrants and established visible minorities. The other argument was that high taxes and pervasive regulation drove both workers and firms into informal, semi-legal channels. Nonetheless, while it is common for economists to correlate an expansion in informal activities with the higher taxes and increased labor legislation of welfare regimes, this makes it hard to explain the striking increases in such practices under neoliberal regimes. In partial explanation, while the former was both ideologically and pragmatically set against informalization, the latter has encouraged an ideal of deregulation positively endorsing decentralization, flexibility, and a self-regulating entrepreneurial workerall supposedly features of informal economy.


Neither a deregulated economy nor a self-regulating economic actor is a sustainable notion, however. Rather, economies are made up of the regulation of productivity and exchange, one way or the other, so a major challenge is to discover the means by which both dynamism and regulation are achieved. By nature decentralized, informal economies provide a wide range of sites for regulation and dynamism. These include employer-employee micro-enterprises, sites of self-employment, domestic enterprises, and homework. They also include networks of interconnection between these (as well as the formal economy and state agencies) and longitudinal means for social reproductionamong them supply, distribution and credit systems, and culturally specific forms for the transmission of property. All of theseand a multitude of others not mentionedprovide sites for possible regulation, facilitation, and invention. This in turn calls into question use of the word economy. As social factors are used to regulate market exchanges and appeals to cultural (or family) belonging are used as a means for regulating labor, the question arises as to whether it is any longer appropriate to refer to the overall phenomenon as an economy at all. There is probably much less distinction between the narrower economists view of informal economy and the broader sociological one. When one realizes the extent to which a wide range of economic practices are regulated through cultures of intimacy and trust combined with ideologies of male authority and female altruism, one sees how the goals of intensifying productivity and even controlling quality expand to embrace a wide range of social practices and relationships.

Like other residual terms, the notion of informal economy will continue to be used to sum up what are in fact hugely varied practices. Insofar as these account for as much as one-half to two-thirds of nonagricultural employment in developing countries and one-quarter in the United States (International Labour Organization 2002), social scientists are challenged to cease conceptualizing these practices as pathological versions of a supposedly normal formal economy and instead develop concepts appropriate to a world that has always existed and yet has just begun to command the attention it deserves (Davis 2006).

SEE ALSO Development Economics; Dual Economy; Economic Growth; Gross Domestic Product; Lewis, W. Arthur; Modernization; Rationality; Regulation; Tradition; Weber, Max


Bromley, Ray, and Chris Gerry, eds. 1979. Casual Work and Poverty in Third World Cities. Chichester, U.K.: Wiley.

Castells, Manuel, and Alejandro Portes. 1989. World Underneath: The Origins, Dynamics, and Effects of the Informal Economy. In The Informal Economy: Studies in Advanced and Less Developed Countries, eds. Alejandro Portes, Manuel Castells, and Lauren A. Benton. Baltimore, MD: Johns Hopkins University Press.

Chen, M. A. 2005. Rethinking the Informal Economy: Linkages with the Formal Economy and the Formal Regulatory Environment. EGDI-WIDER, United Nations University Research Paper #2005/10 1-28.

Davis, Mike. 2006. Planet of Slums. London: Verso.

De Soto, Hernando. 2000. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. New York: Basic Books.

Fernández-Kelly, Patricia, and Jon Shefner, eds. 2006. Out of the Shadows: Political Action and the Informal Economy in Latin America. University Park: Pennsylvania State University Press.

Geertz, Clifford. 1963. Peddlers and Princes: Social Change and Economic Modernization in Two Indonesian Towns. Chicago: University of Chicago Press.

Hart, Keith. 1973. Informal Income Opportunities and Urban Employment in Ghana. Journal of Modern African Studies 11 (1): 6189

Hart, Keith. 2004. Formal Bureaucracy and the Emergent Forms of the Informal Economy. Paper presented at the EGDI-WIDER, United Nations University, conference Unlocking Human Potential, September 1718, 2004, Helsinki.

International Labour Organization. 2002. Women and Men in the Informal Economy: A Statistical Picture. Geneva: International Labour Office, Employment Sector.

Lewis, W. Arthur. 1955. The Theory of Economic Growth. Homewood, IL: R. D. Irwin.

Smart, Alan, and Josephine Smart, eds. 2005. Petty Capitalists and Globalization: Flexibility, Entrepreneurship, and Economic Development. Albany: State University of New York Press.

Stark, David, and László Bruszt. 1998. Postsocialist Pathways: Transforming Politics and Property in East Central Europe. Cambridge, U.K.: Cambridge University Press.

Zhang, Li. 2001. Strangers in the City: Reconfigurations of Space, Power, and Social Networks within Chinas Floating Population. Stanford, CA: Stanford University Press.

Gavin Smith

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informal economy As used by sociologists, the term refers to non-market work, in some cases with the addition of black economy work (which is market work strictly defined). Economists are more likely to use the term as an alternative label for the hidden, underground, or black economy which is imperfectly measured within the Gross National Product. These incompatible uses are the source of many misunderstandings and confusion in debates, particularly in non-disciplinary, interdisciplinary, or policy contexts.

There is a great variety of non-market work encompassed by the sociological term informal economy: unpaid domestic work, consumption work, non-market productive labour, community service work, producing goods and services that are bartered or offered as gifts within extended families or communities, non-legal commerce (in drugs for example), and work on which income tax may not be paid in full (a matter for speculation more often than factual knowledge). Some writers even include market work that is home-based, and thus seems to them to be linked more to household activities, than to the abstract concept of paid employment. The only thing these activities have in common is that they are not covered at all, or only partially, by official statistics on employment. Sociologists often assume that this reveals a failure or inadequacy of the statistics in question; in fact the exclusions are in most cases intentional, and derive from the fact that labour-market statistics are constructed within an economic theoretical framework, rather than a sociological framework.

Economists have always been aware that the total volume of productive work and consumption work are greater than that measured by official statistics of employment and Gross National Product. They reserve the term ‘black economy’ for that portion which should be included but may not be fully reported due to tax evasion. The term ‘marginal’ work or workers is reserved for those people (usually women, and numbering millions in Britain and some other countries) who have very small earnings from employment and are thus, perfectly legitimately, excluded from income tax and social insurance systems, and from related statistics. But in industrial societies, by far the largest volume of work excluded from definitions of employment and GNP consists of consumption work. In Economics and the Public Purpose (1973), the economist John Kenneth Galbraith pointed out that the conversion of women into a crypto-servant class was essential for the development and continued growth of the modern economy: the limits on consumption are severe unless the work can be delegated; the conversion of women from productive work in pre-industrial societies to the role of housewives who administer household consumption, opens up the possibility of indefinitely increasing consumption in market economies, and also contributes to the continuous expansion of service industries. The servant role of women is thus seen as critical for the continuing expansion of consumption in the modern economy.

In the 1980s social scientists became interested in the many types of work excluded from official statistics of employment, and attempted (with partial success) to classify and measure them. Few sociologists fully understand the concepts and operational definitions underlying employment statistics, and operational definitions differ between countries, leading to confusion over boundaries and overlapping definitions between types of informal non-market work and paid employment. For example, if one distinguishes between domestic production work, leisure activities, and domestic consumption work in the household work strategy, the close relationship between participation in the market economy and non-market work becomes clear.

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economy, informal See INFORMAL ECONOMY.