In Emerging Economies, Is There a Role for the Informal Sector?

January 16, 2017

Increasing the formal sector can boost growth, but some experts say countries should also focus on improving conditions in the informal sector, given its staying power.

Street vendors are a vital part of city life in economies around the world. They provide easy access to goods and services and create jobs in local communities. However, they also face many constraints and must contend with long work hours, low pay and sometimes dangerous working conditions that include crime and corruption.

In developing countries across the globe, conditions are similar for street vendors, domestic workers and small shop workers—all part of the informal economy, a sector that’s growing rapidly and makes up to 30 to 80 percent of all non-agricultural employment in developing countries, according to the International Labour Office (ILO). How can countries with large informal sectors better support these workers to break out of the cycle of poverty and low productivity?

Informal employment in 6 countries

As we’ve written, a 2014 McKinsey report on Mexico warned of a productivity tug of war between the country’s globally competitive industries, with productivity growth of 5.8 percent per year, and its growing informal sector where productivity was falling by 6.5 percent per year. Likewise in Nigeria. There a majority of adults are locked into low-productivity jobs and informal work, unable “to escape poverty or attain middle class status,” writes the World Bank.

The informal sector constrains emerging markets’ growth potential

The “youth bulge” in many developing countries adds urgency to this aim. In a blog for the World Bank, Shanthi Nataraj, an economist at RAND, suggests that informal employment may increase in coming years, given that many youth in developing countries are informally employed. In addition, the informalization of formal sector jobs is growing with the rise of contract employment, casual labor and other arrangements. Mexico and India have seen sharp increases in those working in informal jobs in the formal sector, according to the ILO report, jobs like house cleaners or in the “gig” economy, for example.

Informal workers in the urban workforce

Creating more stability and better work conditions for informal workers

Given this apparent staying power, says Nataraj, the question becomes, how can policymakers best improve conditions and help workers who remain informally employed find more stability?

Nataraj has been surveying 3,000 workers and 700 employers in the informal economy in Bangladesh to better understand what these small employers and employees value about their position in the informal economy and how policymakers can respond to them.

One surprising finding, Nataraj says, debunks the idea that all employees in the informal sector are interchangeable and that human capital does not matter. “Even in the informal sector, there are employees with certain skills that employers value,” she says. Those skills are often gained on the job, she says, and employers want to keep those employees. That, she said, should increase employees’ bargaining power for higher wages and more job security.

Knowing what workers value, says Nataraj, is helpful “so that governments can focus their limited resources on trying to create policy to encourage, and enforce, the benefits that workers value the most.”

Preliminary results also point to some low-hanging fruit for policymakers. Both workers and employers, for example, appreciate being notified before a layoff or quitting. Both also value security and safety on the job. Workers also value a formal job contract that spells out terms and conditions, especially length of the job.

One thing is clear. Without more attention to the informal sector, the McKinsey Global Institute argues, the tension between a modern, fast-growing, highly productive economy and a traditional, low-productivity one will continue to be a drag on progress toward truly inclusive growth.

Featured Photo Credit: Getty Images

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