Informal economy in Asia

Most jobs in the developing countries are found in the informal economy, which plays a predominant role in developing economies. Word even has it that the global economic crisis has increased the weight of the informal sector due to job losses in other economic sectors. Therefore, if we want to improve our understanding of how these countries’ economies work, we need to improve our knowledge of the informal economy.
The issue of informality obviously takes on a particular twist in Asia. This continent has seen the most spectacular development in the world’s history in recent decades. Consequently, the region’s governments, more than elsewhere, have decided that there is no need to concern themselves with informality, since it will rapidly fade away with growth.

3 thoughts on “Informal economy in Asia

  1. shinichi Post author

    Journal of the Asia Pacific Economy
    Vol. 17, No. 4, November 2012, 553–559


    The informal economy in Asia: introduction to the issue

    Jean-Pierre Cling, Mireille Razafindrakoto and Franc¸ois Roubaud∗
    IRD (Research Institute for Development)-DIAL, Paris, France

    Most jobs in the developing countries are found in the informal economy, which plays a predominant role in developing economies. Word even has it that the global economic crisis has increased the weight of the informal sector due to job losses in other economic sectors. Therefore, if we want to improve our understanding of how these countries’ economies work, we need to improve our knowledge of the informal economy. Such knowledge is also a key to poverty reduction, a core development policy concern. This is a major challenge from the political, economic and social point of view. Let us not forget that the 2011 Arab Spring started in Tunisia when an informal fruit and vegetable street vendor was harassed by the police and set fire to himself. At the same time, the informal economy remains largely a mystery to researchers and ignored, if not perceived negatively by politicians, as shown by this tragic figurehead of the Tunisian Revolution.

    Despite decades of work on the subject by the International Labour Organization (ILO), the mists that continue to surround the informal economy remain a major obstacle to its inclusion in economic policies. In keeping with international recommendations, the informal sector is defined as all non-agricultural, unregistered, unincorporated enterprises that produce goods and services for sale. Informal employment is defined as employment with no social security coverage.Anumber of characteristics can be considered in this regard for a precise definition: social security coverage, written contract, pay slips, redundancy pay, etc. These definitions find informal employment being made up of two main and distinct components, that is, employment in the informal sector and unprotected employment in the formal sector. In keeping with ILO (1993, 2003) definitions, the informal sector and informal employment make up what is known as the informal economy.

    The lack of accurate statistical data on the informal economy is another concern. This problem is due to a number of factors: hazy definitions outside of the statistical community, lack of interest by the authorities in a sector operating on the fringes of the economy and not paying any or much tax, measurement problems due precisely to the fact that this is a fringe sector, and the preconceived idea that the informal sector is a mark of underdevelopment and will gradually disappear as the countries develop. Whatever the case, the lack of data reliability limits the relevance of the analyses presented in the international reports on this subject (see, in particular, the 2009 ILO-WTO and OECD reports: Bacchetta et al. 2009; J¨utting and de Laiglesia 2009). In addition, the absence of sufficient data generally forces economic studies on the subject to adopt ad hoc (e.g., small- and medium-sized enterprises) and highly approximate definitions (Guha-Khasnobis and Kanbur 2006).

    Aside from the problem of adequate data availability, the reigning confusion has a great deal to do with the multiform nature of informality and workers and businesses’ reasons for working informally. Three dominant approaches are used by the economic literature to identify the origins and causes of informality (Roubaud 1994; Bacchetta et al. 2009):

    • The ‘dualist’ approach is an extension of thework by Lewis (1954) and Harris-Todaro (1970). This approach is based on a dual labour market model where the informal sector is considered to be a residual component of this market totally unrelated to the formal economy. It is a subsistence economy that only exists because the formal economy is incapable of providing enough jobs.

    • Unlike the dualist school, the ‘structuralist’ approach focuses on the interdependencies between the informal and formal sectors (Moser 1978; Portes et al. 1989). Under this neo-Marxist approach, the informal sector is part of, but subordinate to the capitalist system; by providing formal firms with cheap labour and products, the informal sector increases the economy’s flexibility and competitiveness.

    • Last of all, the ‘legalist’ approach considers that the informal sector is made up of micro-entrepreneurs who prefer to operate informally to evade the economic regulations (de Soto 1989). This liberal school of thought is in sharp contrast to the other two in that the choice of informality is voluntary due to the exorbitant legalization costs associated with formal status and registration.

    The issue of informality obviously takes on a particular twist in Asia. This continent has seen the most spectacular development in the world’s history in recent decades. Consequently, the region’s governments, more than elsewhere, have decided that there is no need to concern themselves with informality, since it will rapidly fade away with growth. Research has focused much less on this issue in Asia than in Africa or Latin America, where the analytical investment has been much greater for similar sorts of reasons, top of the list of which is the belief that informality is a permanent feature of the landscape. The available data, sketchy as it is, but informative all the same, clearly show that this reasoning is groundless. Informality not only carries weight in Asia, but is set to last. At best, its forms are slightly different (e.g., with more of an interface with the formal economy and the international process of integration), although this remains to be conclusively proved.

    This special issue sets out to provide some answers to these questions. It takes a selection of papers presented to an international conference, which we held in Hanoi in 2010. Although the analyses focus mainly on Vietnam, they have a much more general reach, as shown by the forays into India and Turkey. Obviously, the six articles in this issue cannot claim to thoroughly cover the issue of informality. We merely hope to help shed light on this obscure phenomenon and possibly stimulate a field of research still largely overlooked.

    The first two articles look into the wage differential between formal and informal sectors, taking into account the intrinsic heterogeneity of the informal sector. The first article (Rand and Torm) classically combines earnings equations and Blinder–Oaxaca decomposition methods applied to a sample of Vietnamese manufacturing SMEs in both sectors. The originality of the approach compared with most of the studies in this area based on household surveys is that it focuses on the firms’ individual particularities and especially their size, which the literature deems one of the main explanatory factors for the premium observed in the formal sector. The downside of this is obviously that individual worker heterogeneity is not observed and therefore that the analysis has to make do with looking solely at average remuneration per firm. Only a matched survey (firms–employees) would lift this constraint.

    The article shows that wages are on average 10%–20% higher in the formal sector, but that the bulk of the earnings gap is due to differences inworker endowments (human capital) and the firms’ productive characteristics, first and foremost their size. The premium found for formal sector employees, which holds when controlling for the firms’ characteristics and is robust to specification changes, suggests that formal firms use an efficiency wage strategy to select and retain the most productive manpower and hence trigger a virtuous cycle: the firms raise their productivity while the employees in return enjoy the benefits of formalization.

    The second paper (Ben Salem and Bensidoun) extends the informal sector focus to all informal employment by looking at segmentation on the labour market in Turkey. Taking the sector allocation model as their basis, the authors set out to determine the number of homogeneous segments in informal employment (i.e., employment not covered by the official social security system) and their properties, in particular, in terms of potential earnings. They adopt a semi-parametric estimation strategy in the finite mixture models category, which has the advantage of circumventing the constraints imposed by the traditional parametric methods. Finite mixture models can estimate earnings equation parameters and endogenously determine the different informal segments, without having to set them down a priori. The models used also take into account participation-related selection bias.

    The article comes to a number of noteworthy conclusions. First, informal employment is clearly heterogeneous and the two-segment partition is statistically the most suitable, since there is a marked difference in returns to individual characteristics in the two segments. Yet this partition does not merely take up the division usually made in the literature, that is, a lower tier made up of informal employees and an upper tier consisting of informal self-employment. Second, and in line with Rand and Torm’s above-mentioned findings, informal workers are doubly penalized (in terms of earnings and protection) in relation to their counterparts in formal jobs, irrespective of the segment considered. In both cases, the vast majority (96%) would earn more if they worked formally. These results hence challenge the assumption of informal work as a choice and the theory of the compensatory wage. More broadly speaking, they give currency to the ‘dualist’ theory based on the presence of segmented labour markets. Consequently, the natural policy recommendation is to reduce the rigidities that tend to restrict formal labour demand. Nevertheless, the authors guard against this type of policy, which could end up driving wages down and hence prove incompatible with the decent work agenda.

    Much like Vietnam and Turkey, India is experiencing a massive informality phenomenon. The next article (Bairagya) looks into the dynamics and determinants of informality in this country (focusing on both informal employment and the informal sector). In addition to the fact that the number of informal workers in India is the highest in the world, one major point of interest in the Indian case is that long-term series are available dating back to the early 1980s. The paper is presented in two major sections. The first part adopts a macroeconomic approach, addressing growth in informal employment in its different components. The second section takes a more microeconomic focus to analyze the determinants of employment in the informal sector, using probit sector choice models on individual data.

    On the first level, and despite the growth upturn observed for nearly two decades, informal employment remains extraordinarily high (over 90% of total employment since the early 1980s) and shows no sign of slowing. It is found in all economic sectors. Moreover, the share of informal employment in the formal sector has shot up (from 35% to 44% from 2000 to 2005), giving some substance to the ‘structuralist’ theory. However, this remains restricted to a minute segment of informal employment. The vast majority of informal employment is made up jobs in the informal sector, accounting for no less than 86% of total employment in both 2000 and 2005. This predominance, combined with the negative characteristics of informal sector jobs and workers as shown by the econometric analyses, endorses the idea that it is more the ‘dualist’ theory that prevails on the Indian scene. The decomposition of the estimates into three sub-samples based on the states’ development levels adds an interesting perspective to this general analysis. Whereas, on average, most of the factors associated with the probability of having a job in the informal sector are common to all the territories, the disadvantaged and leastmobile castes appear to have the least chance of escaping this sector in the wealthiest states. So not only has India’s development process in recent decades been unable to reduce the share of informal employment, but it has also had highly uneven effects by reducing access to the formal sector and quality jobs for the most vulnerable segments of the labour force.

    In this changing world, employment conditions in the formal sector are probably the most significant factor of change. Castel and To’s article focuses precisely on the second component of the informal economy, that is, informal employment in the formal sector. Using data from the census of enterprises in Vietnam, the authors look into the reasons why some of them do not declare all or part of their manpower to the social security system, albeit compulsory to do so, with the direct underlying question as towho stands to gain from this illicit reduction in labour costs. Do the firms, in so doing, increase their profits? Or do the employees benefit from the consequent financial headroom by securing higher wages? This article ingeniously tests the above-mentioned central assumption of the structuralist school, which, although attractive in principle, cruelly lacks robust empirical elements for conclusive support.

    The authors set to quantifying the total under-declaration of wages to the social security contributions body before moving on to econometric analyses of the microeconomic determinants of the sum of average wages. The results of the different types of estimations produce convergent conclusions. Other things being equal, the employees of under-declaring firms earn higher wages than the employees of compliant firms.

    Although part of the non-payment of social security contributions can be explained by system shortcomings (businesses are legally bound to declare the starting wage, but not the wages subsequently paid), workers gain a direct advantage from not being affiliated with the social security system. This situation can but undermine the Vietnamese authorities’ 2020 universal coverage policy. It will not be enough, for the success of this policy, to tighten controls and step up penalties for non-compliant firms, as is envisaged today. It will be necessary to calculate contributions based on a real cost–benefit analysis for the employees and to conduct information campaigns for these employees on the advantages of forgoing part of their direct wage.

    Looking again at Vietnam, Cling et al. set out to identify the factors that drive informal firms to become formal, that is, to register with the administration, or to remain informal. Although this article concentrates solely on the country’s two main cities (Hanoi and Ho Chi Minh City), it has the merit of using first-hand representative surveys that cover all household businesses, formal and informal. In general, the question as to why informal enterprises exist is poorly handled in the literature, since existing databases are not suited to addressing this issue. Household surveys (of the Labour Force Survey type) are not designed to address entrepreneurial behaviour, whereas business surveys, when they do cover micro-enterprises, are not able to grasp the ‘invisible’ part of the informal sector (roving or home-based). Only the mixed (household–enterprise) surveys can solve thi bias, but even these are generally restricted to the informal sector. As an added plus, in addition to their coverage, the surveys used in the article draw on detailed data on the interactions between household businesses and the different State agencies as well as the perceived pros and cons of registration, information that is usefully rounded out by in-depth qualitative interviews.

    The article’s prime conclusion is that, although most of the informal businesses operate ‘illegally’ (they do not have the required business licence; a finding that ties in with Rand and Torm’s findings on a totally separate sample), this ismore due to obscure legislation and a lack of knowledge of the registration procedures than the mark of a deliberate intention to dodge their obligations. This legal grey area may well foster the emergence of spontaneous, productive activities, but it also forms a particularly fertile breeding ground for illicit transactions and corruption. And note that escaping corruption (whether perceived as a potential risk or actually experienced) is one of the main stated benefits of registration, a diagnosis confirmed by the econometric analyses. Access to information, the market and large business orders also drive the informal entrepreneurs to register, highlighting the importance of the initial reasons behind setting up in business when it comes to the formalization process. For example, entrepreneurs who set up in business on their own out of choice (desire for independence or family tradition) are significantly more inclined to become formal than their counterparts who resign themselves to this alternative for want of a wage-earning job. The latter are caught in an ‘informality trap’ as their activity serves more to generate makeshift earnings than to generate a growth and accumulation dynamic. The massive, obscure informal sector, which cannot be reabsorbed in the short term even in the most optimistic growth hypotheses, and the reasons for its resilience have driven the authors to suggest that the Vietnamese authorities gauge its scale (which is not yet the case) and put in place policies for it (recognition of its existence, clarification of the legal framework and formalization incentives).

    Informal sector dynamics are not only conditioned by the domestic economy’s internal processes, they also tie in with the international environment, directly or indirectly, via various mechanisms: prices, trade and capital flows, sub-contracting, remittances, etc. The last article in this issue (Tran et al.) studies one of these effects by analyzing the impact of international migration on the informal sector. This study makes perfect sense in Vietnam where the authorities have introduced an active manpower export policy specially targeted at unskilled and low-skilled labour with the explicit objective of contributing to poverty reduction. The authors base their work on a specific representative survey of households with at least one migrant member (whether still away or returned), including a control sub-sample of non-migrant households. They use propensity score matching methods to compare the two types of households, while controlling for bias induced by the selective nature of migration.

    The findings are somewhat disappointing from the point of view of the vitalization of the informal sector. First, although migration in part concerns the poorest households, a large proportion of migrants are from wealthy households that send their children to study abroad. Second, the remittances sent by migrants are used massively for consumption (and housing improvements) and very marginally to invest in family businesses, which are themselves fewer in number among migrant households. Lastly, the analyses show that international migration has no significant effect on the creation of family businesses, whether through the mobilization of financial resources sent by migrants or through the acquisition of specific skills and experience to foster entrepreneurship once the migrants have returned to the country. It is therefore apposite to question the effectiveness of a policy that could end up raising unemployment as people wait for a job in the formal sector.

    To conclude, the articles in this issue propose different approaches to the question of informality. They range from the possible macroeconomic causes of informality, that is, labour market segmentation (Rand and Torm, Ben Salem and Bensidoun) to the factors determining individuals’ sector choices (Bairagya), and the business strategies concerning the registration of their production units (Cling et al.) and the declaration of their employees to social security (Castel and To). They also show that none of the theories normally put forward can alone explain the existence and persistence of the informal sector and informal jobs. Although the labour market ‘dualism’ theory would appear to apply, it is far from satisfactory given the findings on the heterogeneous nature of the sector and informal jobs (Ben Salem and Bensidoun, Bairagya, and Cling et al.). The ‘structuralist’ hypothesis,which posits that formal businesses seek above all to exploit informal workers, is undermined by the observation that the non-declaration of employees also benefits these same employees, at least in the short term, by securing them higher wages (Castel and To). Lastly, the ‘legalist’ approach is invalidated by the observation that the choice of informality by household business heads is due less to a desire to circumvent the legislation than to the obscure legal framework and the lack of a formalization incentive policy (Cling et al.). Given the different constraints on the labour market, and especially the formal sector’s limited capacity to absorb a large part of the manpower in the countries studied, the question could be put as to whether the legislation is not kept vague on purpose. Such a ‘laissez-faire’ strategy could be in the states’ interest to offset their want of policies able to deal with the insecure conditions endured by (mostly poor) workers massively employed in informal situations. Tran et al. demonstrate the limits of the Vietnamese international migration incentive policy, intended to both solve the unemployment problem and encourage the development of private initiatives among poor households based on remittances and skills acquired abroad. Nevertheless, given the budgetary constraints that households face, they cannot alone develop, at their level, strategies to break out of their insecurity without specific public support policies.

    Precise knowledge of the situations in the countries and the sectors studied based on relevant data has given us the in-depth analyses presented in this issue. All of the articles have a reach that transcends their contextual particularities by opening avenues of research and demonstrating the need to deal with the issue of informality at different levels (macro/national, business, household and individual). They bring to light the complexity of the public policies that need to be put in place to address the issue of informality. And indeed, a wide range of measures is required. These measures cover manpower education and training policies (Bairagya, Rand and Torm), administrative procedure transparency and simplification, including social security (Cling et al., Castel and To), and the creation of a conducive environment to foster the productivity of informal production units (Rand and Torm, Cling et al.). The articles also show that, even though informal status is sometimes chosen, it is more of a Hobson’s choice (no choice at all) than a willing choice. Therefore, rather than a fast-track formalization strategy (penalizing informal workers), only incentive policies and information campaigns for the gradual formalization of both unincorporated enterprises and employees, once the constraints and uncertainties weighing on their future have been cleared, can produce results in the medium and long run.

  2. shinichi Post author

    Informal economy in Asia and the Pacific


    In many developing countries in the Asia-Pacific region the informal economy constitutes a substantial and important portion of the labour force. The “informal economy” refers to all economic activities by workers that are – in law or in practice – not covered (or insufficiently covered) by formal employment arrangements. Although it is hard to generalize about the quality and nature of informal employment, the characteristics include a lack of protection for non-payment of wages, retrenchment without notice or compensation, unsatisfactory occupational health and safety conditions and an absence of social benefits such as pensions, sick pay and health insurance.

  3. shinichi Post author


    それぞれの国が発表する「統計」にあらわれない「informal economy の数値」を足すと、アジアの国々の統計は、ずいぶんと違ってくる。





Leave a Reply

Your email address will not be published. Required fields are marked *