The informal sector is a major source of economic activity and job opportunities in poor countries as well as emerging economies. In sub-Saharan Africa, the size of the informal sector is estimated to be about 38 percent of official GDP, employing over 70 percent of the population. In Latin America, about 50 percent of jobs are considered to be informal, while in South Asia the figure is estimated to be close to 80 percent. Why do businesses remain informal? What gains in productivity or profitability do they forego by as a result of that choice?
Some researchers view informality as a survival strategy; they see the informal sector as characterized by low wages and poor working conditions, without much prospect for growth. Other studies indicate that informal firms are often led by micro-entrepreneurs, who prefer to stay unregistered to avoid the additional costs and administrative burden associated with formalization.
The bottom line: there is little we can say about the motivations, productivity, or other characteristics of informal firms in a generalized, global context. The size of productivity gaps between registered and unregistered businesses, the costs and benefits of formalization, and firms' motivation for staying in the shadow economy tend to differ from country to country. Gelb et al. (2009) show that informal firms in East African countries differ a great deal from their Southern African counterparts. While informal businesses in East African countries were found to be fairly productive relative to formal ones with similar characteristics, informal firms in Southern Africa lagged behind their registered peers in almost all aspects. Our current analysis, based on recent data from the World Bank’s Enterprise Surveys for five countries—the DRC, Ghana, Kenya, Myanmar, and Rwanda—again shows that informal firms vary a great deal in their differences with formal firms, whether it be on measures of productivity or access to public services such as electricity and water. Our results also reveal a number of striking differences and similarities between formal and informal firms with regards to a wide range of issues:
- How likely is it that informal firms are connected to the electricity grid? Do they experience more power outages than their formal counterparts?
- Are informal firms less likely to have to a bank account and access to loans than formal ones?
- Does crime affect informal and formal firms differently?
- Do owners and managers of informal firms have little education?
- How do informal firms’ expectations about the costs of formalization contrast with reality?
CGD blog posts reflect the views of the authors, drawing on prior research and experience in their areas of expertise. CGD is a nonpartisan, independent organization and does not take institutional positions.