RETHINKING FORMALIZATION: WHO, WHAT, WHY, AND HOW? Marty Chen Harvard University WIEGO UN Department of Economic and Social Affairs (DESA) Development Forum on Productive Employment and Decent Work May 8-9, 2006 New York

PRESENTATION The Formalization Debate: different schools of thought The Informal Economy: who are we talking about? what do we know? The Informal Economy, the Formal Economy, and the Regulatory Environment: what are the linkages? Informality and Formality: what are the costs and benefits of each? Rethinking Formalization: conclusions and recommendations

THE FORMALIZATION DEBATE: DIFFERENT SCHOOLS OF THOUGHT Who? informal entrepreneurs who choose to operate informally in order to avoid taxation informal entrepreneurs who choose to operate informally in order to avoid cumbersome bureaucratic procedures petty producers + unprotected workers subordinated to the formal economy “survivalists” What? bringing informal enterprises under the regulatory environment simplifying the regulatory environment for informal enterprises regulating the relationship between “big business” + subordinated producers and workers providing government services to survivalists Why? to increase the tax base to unleash the productive potential of informal enterprises to address the unequal relationship between the formal and informal economies to help survivalists earn a livelihood + to reduce poverty

EXPANDED DEFINITION OF THE INFORMAL ECONOMY Self-employment in informal enterprises: self-employed persons in small unregistered or unincorporated enterprises, including:  employers  own account operators  unpaid family workers Wage employment in informal jobs: wage workers without legal protection for formal or informal firms, for households, or with no fixed employer, including:  non-standard employees of informal enterprises  non-standard employees of formal enterprises  casual or day labourers  industrial outworkers (also called homeworkers)

INFORMAL ENTERPRISES: DISTRIBUTION BY SIZE

INFORMAL ECONOMY: AVERAGE EARNINGS AND SEGMENTATION BY SEX

INFORMAL ENTERPRISES AND FORMAL FIRMS Few informal enterprises, except some survival activities, operate in total isolation from formal firms. Most source raw materials from and/or supply goods or services to formal firms either directly or through intermediaries (often other informal enterprises or informal contractors). The nature of the linkage in sourcing and supplying of goods or services is likely to differ by whether the transaction takes place through: oopen market exchange osub-sector networks ovalue chains

INFORMAL WAGE WORKERS, INFORMAL FIRMS, AND FORMAL FIRMS Informal wage workers, by definition, are hired under non-standard employment relationships without legal recognition and protection Some informal wage workers are non-standard employees for informal enterprises, formal firms, or the public sector Some informal wage workers are not legally recognized as employees because their employment relationship is either: odeliberately disguised ogenuinely ambiguous onot clearly defined Other informal wage workers have no fixed employer (e.g. day labourers) or have multiple employers (e.g. domestic workers)

INFORMAL ENTERPRISES AND THE FORMAL REGULATORY ENVIRONMENT Existing linkages between informal enterprises and the formal regulatory environment differ by context and type of activity as follows: Registration:  over-regulation  under-regulation  lack of regulation Taxation - both direct and indirect:  high  low  none Economic Regulations and Policies - both targeted and non-targeted:  biased against or towards micro enterprises (vs. larger enterprises)  biased against or towards women's enterprises (vs. men’s enterprises)

INFORMAL JOBS AND THE FORMAL REGULATORY ENVIRONMENT informal jobs are, by definition, unregulated + unprotected labour markets have been increasingly de-regulated in recent years formal jobs have been increasingly informalised in recent years

BENEFITS AND COSTS OF INFORMALITY Benefits of Informality: tax avoidance competitive advantage flexibility and convenience Costs of Informality: direct “out of pocket” costs odirect + indirect taxes ohigh costs of capital ohigh costs of electricity + transport operiodic “shocks” indirect costs ovariability and volatility of work/income olack of social protection olack of capital + other assets olack of training + mobility prospects olack of legal status + bargaining power

COSTS AND BENEFITS OF FORMALIZATION Costs of Formalizing: for informal entrepreneurs registration taxation regulation Benefits of Being Formal:  enforceable contracts  access to formal financial services  legally-recognized rights  access to public infrastructure + services  access to tax-funded social protection  membership in formal associations

FORMALIZING INFORMAL ENTERPRISES: WHAT DOES THIS MEAN? registration + taxation + regulation legally-recognized property rights benefits of being formal enterprises: oaccess to finance + market information oaccess to public infrastructure + services ouse of public space oenforceable commercial contracts oaccess to government subsidies + incentives omembership in formal business associations

FORMALIZING INFORMAL JOBS: WHAT DOES THIS MEAN? legal recognition as workers legal protection as workers rights and benefits of being formal workers, including: oright to organize + bargain collectively ofreedom from discrimination ominimum wage oemployer contributions to health + pensions omembership in formal trade unions

RETHINKING FORMALIZATION: CONCLUSIONS There are ‘hidden costs’ of working informally There are often ‘hidden biases’ in existing policies and regulations against informal enterprises and informal workers The goals of formalization should be to: minimize - ‘hidden costs’ of working informally ‘hidden biases’ against informal enterprises/workers maximize – equitable relations between formal firms, informal enterprises, and informal workers productivity and competitiveness of informal enterprises protection and rights of informal workers

RETHINKING FORMALIZATION: RECOMMENDATIONS # 1 – Expand formal employment opportunities # 2 – Create incentives for informal enterprises to formalize # 3 – Regulate labour markets to provide basic worker benefits and rights to informal workers + create incentives for socially responsible employment practices # 4 – Create mechanisms and financing arrangements, including employer contributions, to provide social protection to all workers # 5 - Promote participatory policy processes and inclusive rule-setting institutions that include representatives of informal entrepreneurs and informal wage workers