Less Costs and More Freedom Drive Informal Economies

Interesting commentary from World Bank’s East Asia & Pacific Blog on the informal economy (bold highlight mine)…

``Recently my colleague Ryan Hahn of the PSD blog wrote about an interesting story on sweatshops. This refers to an op-ed of Nicholas Kristof, a columnist for the New York Times, titled "Where Sweatshops Are a Dream". On his own blog, he clarifies: "My point is that bad as sweatshops are, the alternatives are worse. They are more dangerous, lower-paying and more degrading."

``This is indeed part of a more general point about the so-called informal economy. Creating strict standards for the formal economy – to improve working conditions and living standards – often acts as a disincentive to become formal. These standards create a barrier that prevents many workers from having a job in the formal sector and leaves them without protection in the informal sector (or even worse, without job). This is something all countries, including developed countries, are struggling with: How to encourage the upgrading of standards without being counterproductive?”

We think the unstated problem is about costs. If the cost of doing business is substantially higher in a regulated ‘formal’ economy, then obviously it becomes a disincentive, especially for low capital intensive businesses. And by costs we see it in the context of both monetary and utility/convenience from “compliance costs”.

And in terms of convenience, informal economies could also signify thefreedom to operate, to quote Stefan Karlsson ``since informal markets are markets where people do not have their freedom restricted by the state this should if anything be counted as something positive. The larger the informal market the greater chance people have to conduct their business without being taxed and regulated by government officials. In countries with a small informal sector it is far more difficult to find other people with whom you can do business and practice division of labor without having your freedom restricted by the state.”