Wednesday Oct 16

EXCERPT FROM The Informal Economy is Exploding — What Do We Do About It?

Potential policy objectives

Reviewing the possible policy objectives open to governments when tackling the informal economy, there are four hypothetical options. Governments can select to either: take no action; eradicate the informal economy; deregulate the formal economy; or formalize the informal economy. At first glance, some of these policy objectives may seem a little outlandish. However, all these policy objectives have been advocated by various scholars over the past few decades. As such, none can be rejected without evaluating their advantages and disadvantages.

Take no action

The first policy objective that might be pursued is to do nothing about the informal economy. The rationales for taking no action are that:

• If the informal economy is relatively small, the revenue-to-cost ratios of reducing the informal economy or formalizing informal work may not be cost effective;
• The informal economy is a test-bed out of which emerges a large proportion of new business ventures (Williams & Martinez 2014e), so this realm should be left alone; and
• The informal economy is in large part composed of paid favors for family, friends, neighbors and acquaintances which in market-oriented societies is a main vehicle for active citizenship, so this realm should be left alone in order that governments do not with one hand destroy precisely the active citizenship that with another hand it is seeking to foster. These paid favors, furthermore, may often constitute the initial monetary exchanges out of which people recognize the possibility that an entrepreneurial venture might be created, and which enables them to test out their idea for a business venture.

For these reasons, a potentially viable policy objective may be to take no action. However, doing so will mean that all the negative consequences for formal businesses and workers, informal enterprises and workers, their customers, governments and the wider society will remain intact.

Until now, there has been no rigorous evaluation of the magnitude of these positive and negative consequences. This lacuna in scholarship will need to be filled in future. Even if a rigorous evidence-base is
lacking, nevertheless, the widespread normative consensus is that on balance, the negative consequences of doing nothing outweigh the positive consequences and it is therefore not a valid policy approach.

However, even if pursuing solely this policy objective is not viable, it should perhaps not be entirely dismissed. For example, it could be considered that doing nothing is relevant in relation to small-scale one-off odd-jobs conducted as paid favors to help close social relations. If pursued, moreover, this would free government resources in labor inspectorates and tax administrations to concentrate on larger-scale tax evasion by businesses. In consequence, even if it is not relevant in relation to all informal work, this policy objective may be applicable to certain types of informal work. Overall, however, the negative consequences across all stakeholders of pursuing a laissez-faire approach means that intervention in the informal economy is required. What form of intervention in the informal economy, therefore, is required? Three alternative policy options exist in this regard.

Deregulate the formal economy

One policy option might be to deregulate the formal economy. The logic for pursuing this objective can be found in the neoliberal theoretical explanation that depicts the informal economy to be the outcome of over-regulation (De Soto 1989, 2001; London & Hart 2004; Nwabuzor 2005; Small Business Council 2004). Viewed from this neoliberal perspective, informal workers are viewed largely as own-account workers voluntarily choosing to operate in the informal economy on a self-employed basis and are celebrated as heroes who are casting off the shackles of state over-regulation (e.g. Sauvy 1984; De Soto 1989). Informal workers are thus only breaking unfair rules and regulations imposed by what is perceived as an excessively intrusive state.

The objective is therefore to reduce taxes and cumbersome state regulations to free those in the formal economy from the constraints that supposedly force up labor costs and prevent flexibility, and act as a disincentive to those seeking to operate in the formal economy. As Castells and Portes (1989: 13) put it, “In an ideal market economy, with no regulation of any kind, the distinction between formal and informal would lose all meaning since all activities would be performed in the manner, we now call informal.” With fewer regulations, the distinction between formal and informal work would thus wither away so that the formal and informal economies would become inseparable since all activities would be performed in the manner now called “informal”, although such activity would be “formal” since it would no longer be breaking any rules.

However, several problems exist with pursuing this policy goal of deregulating the formal economy. First, there is little evidence that reducing taxes and deregulating the formal economy reduces the size of the informal economy. Secondly, even if deregulation were to lead to a reduction in the amount of so-called formal regulated work and a growth of what is now termed informal work, the outcome would likely be lower quality work and a levelling down rather than up of working conditions (Williams 2006a).

Importantly, nevertheless, even if pursuing solely this policy option is not viable, it is again the case that it might be applied in some limited instances. Deregulation, such as in the form of the simplification of compliance, can be a useful tool when helping businesses start-up on a formal basis from the outset. If the regulatory burden is high and complex for businesses, and simpler compliance is possible, then deregulation will play an important role in tackling this type and reason for informality. The deregulatory approach is not a viable option across the whole informal economy, however, because it would produce a levelling down rather than up of working conditions. It would be formality in the context of lower levels of social protection and fewer rules and regulations, such as in relation to occupational health and safety, working conditions and customer protection. In sum, even if deregulation were to reduce the magnitude of the informal economy, the impact would be doubtless a widening of inequalities and a deterioration of working conditions compared with more regulated countries.

Eradicate the informal economy

Another policy objective might be to eradicate the informal economy. At first glance, eradicating the informal economy seems a valid option. In recent decades, however, numerous problems have been found with the practicability and desirability of eradicating the informal economy. On the one hand, there is the practical problem of whether it can be achieved as well as how to do it. On whether it can be achieved, such a goal is based on the premise that government authorities can be sufficiently powerful to eradicate the informal economy. Whether this is the case in those global regions where the informal economy is most prevalent is questionable. The global regions where the informal economy is most prevalent have weak formal institutional environments. Whether the power of authorities can be sufficiently enhanced to make the eradication of the informal economy feasible, or even its significant reduction, is debatable. Indeed, even when advanced market economies have sought to do so, the problem governments have confronted is that beyond a certain point, the cost of eradicating the informal economy outweighs the benefits. There is a point, therefore, beyond which it is difficult to progress when seeking to eradicate the informal economy.

On how its eradication can be achieved, the conventional approach has been to view those operating in the informal economy as “rational economic actors” who evade compliance because the pay-off is greater than the expected cost of being caught and punished (Allingham & Sandmo 1972), and to seek to change the cost/benefit ratio confronting actual or likely participants by concentrating on the cost side and increasing the perceived or actual likelihood of detection and the penalties and sanctions for those caught (Grabiner 2000; Richardson & Sawyer 2001). This, therefore, seeks to elicit behavior change using “sticks” to punish those engaged in “bad” behavior. However, issues have been raised about the efficiency and effectiveness of this deterrence approach. Although some find that improving detection and/or penalties reduces the informal economy (De Juan et al. 1994; Slemerod et al. 2001), others identify that the informal economy grows (Bergman & Nevarez 2006; Murphy 2005). Indeed, some eminent scholars have even concluded that “it is not sensible to penalize illicit work with intensified controls and higher fines” (Schneider & Enste 2002: 192). This is because it alienates these informal workers and businesses, decreases their willingness to comply and reduces their belief in the fairness of the system, especially if the fines are too high and they are treated in ways they do not perceive as fair and just (Murphy 2005). It is not just the practical issue of whether it is feasible to eradicate the informal economy and how its eradication can in practice be achieved that results in questions being asked about the policy goal of eradication.

Eradication is also perhaps not desirable. If the eradication of the informal economy is sought, then not only may it be costly for governments to achieve, but in doing so, governments will destroy precisely the entrepreneurial endeavor and active citizenship that they are seeking to nurture and develop in order to promote economic development and growth, and social cohesion. The resulting challenge for government is to “join-up” its policies towards the informal economy with its wider policies towards entrepreneurship and active citizenship. There is also perhaps a need to join up its policy towards the informal economy with its wider policies on employment creation and social cohesion.

Importantly, however, even if pursuing solely eradication as a policy goal is not viable, it could be pursued in some circumstances. In situations where informal workers and informal businesses have been given every opportunity to formalize but do not, then governments must be able to punish those not complying. In these contexts, the tools of an eradication approach, including penalties and sanctions, are needed. On its own, however, the eradication approach is not perhaps viable since this policy approach often contradicts wider policy goals associated with harnessing entrepreneurship, active citizenship, social cohesion and fuller-employment.

Move informal work into the formal economy

A fourth and final policy option is to move informal work into the formal economy. Beginning with the potential disadvantages, a major one is that those starting businesses will no longer be able to undercut the competition and to test-trade in the informal economy when starting up (although the latter issue is not relevant if this approach recognizes that many business start-ups are on a journey to formalization and facilitates them to take this journey), and another major disadvantage is that customers will need to pay the full market price which might mean that the role of the informal economy in providing cheaper goods and services will no longer be available. The benefits of moving informal work into the formal economy, nevertheless, outweigh the costs. These benefits can be related to the various groups of the population with a stake in this matter, namely formal and informal businesses, informal workers, customers and the government.

For formal businesses, the benefits of moving informal work into the formal economy are that it eliminates the unfair competitive advantage of informal over formal enterprises (Andrews et al. 2011; Evans et al. 2006; Karlinger 2013; Renooy et al. 2004), and enables a “high road” rather than “low road” approach to be pursued by businesses whereby they move towards ever greater regulatory standards on corporate social responsibility and conditions of work such as health and safety and labor standards (OECD 2016; Williams & Windebank 1998; Williams et al. 2013).

For informal businesses, the benefits of moving work from the informal economy into the formal economy are that: they can escape being pressured into exploitative supply chain relationships with the formal sector (Gallin 2001; Williams & Windebank 1998); have the same levels of legal protection as formal businesses (Castells & Portes 1989; ILO 2002a; Williams & Windebank 1998); and overcome the structural impediments to their development and growth, such as gaining access to capital and being able to secure the advice and support available to formal businesses (ILO 2002; OECD 2016; Williams et al. 2013).

Informal workers, meanwhile, especially those living in poverty, benefit from shifting their work into the formal economy because they: gain access to health and safety standards in the workplace (Evans et al. 2006; Gallin 2001; ILO 2002; Williams & Lansky 2013); enjoy the same employment rights as formal workers (Evans et al. 2006); gain access to mortgages and credit since their pay is official and recognized by lending institutions (Leonard 1994; Williams 2007); benefit from greater job security (Williams 2018); can get an employer’s reference (ILO 2002); gain access to other legal rights such as the minimum wage, tax credits and the working hours directive (Leonard 1994; Renooy et al. 2004; Williams & Windebank 1998); can build-up rights to the state pension and other contributory benefits, and access occupational pension schemes (Gallin 2001; ILO 2002); enjoy bar- gaining rights (ILO 2002; Williams & Lansky 2013); improve their ability to evidence their employability; and reduce their constant fear of detection and risk of prosecution (Grabiner 2000).

For customers of the informal economy, meanwhile, the advantages of moving work from the informal economy into the formal economy are that they: benefit from legal recourse if a poor job is done; have access to insurance cover; enjoy guarantees in relation to the work conducted, and benefit from greater certainty that health and safety regulations have been followed.

Finally, and for governments, the benefits of moving work from the informal economy into the formal economy are that it: increases the tax revenues for the state, including income tax, national insurance and VAT (Evans et al. 2006; Grabiner 2000; Williams 2004b; Williams & Windebank 1998); has beneficial knock-on effects by increasing the money available to governments to pursue social cohesion (Williams & Windebank 1998); results in improved trade union and collective bargaining (Gallin 2001); allows the creation of more formal jobs to enable societies to move closer to the goal of full-employment; enables a joining-up of the policy approach towards the informal economy with the policy approaches towards entrepreneurship and active citizenship (Dekker et al. 2010; European Commission 2007a; Renooy et al. 2004; Small Business Council 2004; Williams 2006a); improves regulatory control over the quality of jobs and services provided in the economy (Gallin 2001); and encourages a more positive attitude towards the law more widely (Renooy et al. 2004).

In sum, this brief review of the four policy objectives displays that the first goal of taking no action leaves intact the current disadvantages for formal entrepreneurs (e.g. unfair competition), informal entrepreneurs (e.g. the inability to gain access to credit to expand), customers (e.g. no guarantee of health and safety standards) and governments (e.g. taxes owed are not collected). The second goal, eradicating the informal economy, would result in governments repressing exactly the entrepreneurship and active citizenship that they wish to foster, and the third goal, deregulating the formal economy, would level down rather than level up working conditions. Transferring informal work into the formal economy is consequently the most viable policy objective. How, therefore, can this be achieved?

Excerpted from The Informal Economy by Colin C. Williams Copyright (c) 2019

Colin C. Williams. Used by arrangement with Agenda Publishing. All rights reserved. Coin Williams is Professor of Public Policy at the University of Sheffield in England.

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