Case The Informal Economy: What It Is and Why It Is Important? The informal economy refers to…


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The Informal Economy: What It Is and Why It
Is Important?

The informal economy refers to commercial
activities that occur at least partly outside a governing body’s observation,
taxation, and regulation. In slightly different words, sociologists Manuel
Castells and Alejandro Portes suggest that the “informal economy is
characterized by one central feature: it is unregulated by the institutions of
society in a legal and social environment in which similar activities are
regulated.” Firms located in the informal economy are typically thought of as
businesses that are unregistered but that are producing and selling legal
products (that is, they sell many of the same products you might buy in legal
businesses but perhaps cheaper because they do not pay government fees and
taxes). In contrast to the informal economy, the formal economy is comprised of
commercial activities that a governing body taxes and monitors for society’s
benefit and whose outputs are included in a country’s gross domestic product.
For some, working in the informal economy is a choice, such as is the case when
individuals decide to supplement the income they are earning through employment
in the formal economy with a second job in the informal economy. However, for
most people working in the informal economy is a necessity rather than a
choice—a reality that contributes to the informal economy’s size and
significance. Although generalizing about the quality of informal employment is
difficult, evidence suggests that it typically means poor employment conditions
and greater poverty for workers. Estimates of the informal economy’s size
across countries and regions vary. In developing countries, the informal
economy accounts for as much as three-quarters of all nonagricultural
employment, and perhaps as much as 90 percent in some countries in South Asia
and subSaharan Africa. But the informal economy is also prominent in developed
countries such as Finland, Germany, and France (where the informal economy is
estimated to Mini-Case The Informal Economy: What It Is and Why It Is
Important? account for 18.3 percent, 16.3 percent, and 15.3 percent,
respectively, of these nations’ total economic activity). In the United States,
recent estimates are that the informal economy is now generating as much as $2
trillion in economic activity on an annual basis. This is double the size of
the U.S. informal economy in 2009. In terms of the number of people working in
an informal economy, it is suggested that “India’s informal economy …
(includes) hundreds of millions of shopkeepers, farmers, construction workers,
taxi drivers, street vendors, rag pickers, tailors, repairmen, middlemen, black
marketers, and more.” There are various causes of the informal economy’s growth,
including an inability of a nation’s economic environment to create a
significant number of jobs relative to available workers. This has been a
particularly acute problem during the recent global recession. In the words of
a person living in Spain: “Without the underground (informal) economy, we would
be in a situation of probably violent social unrest.” Governments’ inability to
facilitate growth efforts in their nation’s economic environment is another
issue. In this regard, another Spanish citizen suggests that “what the
government should focus on is reforming the formal economy to make it more
efficient and competitive.” In a general sense, the informal economy yields
threats and opportunities for formal economy firms. One threat is that informal
businesses may have a cost advantage when competing against formal economy
firms because they do not pay taxes or incur the costs of regulations. But the
informal economy surfaces opportunities as well. For example, formal-economy
firms can try to understand the needs of customers that informal-economy firms
are satisfying and then find ways to better meet their needs. Another valuable
opportunity is to attract some of the informal economy’s talented human capital
to accept positions of employment in formal economy firms.

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