The Free Market 9, no. 5 (May 1991)
Governments have always intervened in the economy, but today’s State—armed with modern data collection as well as an interventionist ideology—has taken us to a new level of regulation and taxation.
Faced with this, people find less costly ways to work, produce, and exchange, even if it means doing so unofficially. This is one reason the State can never achieve total economic control—witness the underground economies in the socialist world.
The socialist world is not unique, however, as economists have recently begun to notice. All over the world, people are escaping the big government net by going “informal,” a term coined by economists researching African rural life in the early 1970s.
Today the term refers to that sector of all economies outside of government control, those enterprises which need not fill out government paperwork, abide by government regulations, have their profits taken, or deal with union demands.
Although extremely diverse, informals have features in common throughout the world. Most are small, with a dozen workers or less. These workers receive few if any of the “social benefits” found in the formal sector: unemployment insurance, health insurance, union organization, and the minimum wage. Their conditions of work do not meet official health and safety standards. The firm’s location usually violates zoning ordinances. And the management is not bound by official standards of accounting.
Research is still spotty, but it is now thought that informals account for at least 20%, and perhaps as much as 60%, of worldwide non-agricultural employment. No one can say how much informals contribute to overall production, except to say that it is much more than anyone had previously thought.
In western nations, informals have grown as government intervention has increased. Health, safety, and environmental controls; employment taxes and regulations; affirmative action and other racial regulations; and labor laws have driven entrepreneurs and workers into informal markets.
In the U.S., the biggest source of informalism is labor-law violations. Some estimate that 15% of American workers are involved in informalism, accounting for as much as 5% of GNP. Italy’s informal market is much bigger, partly because the government largely ignores it. One estimate has 49% of employed women, and 18% of men, working informally, and contributing 11% of total Italian production. In some areas of Spain, 38% of workers are hired on an informal basis; overall 22% of workers are involved. And plenty of other industrialized countries haven’t been studied yet.
Leaving aside socialist countries (where it has been wildly underestimated), informalism provides an economically critical role in the third world. A new study commissioned by the Organization for Economic Cooperation and Development (OECD) and involving thousands of economists, has assembled the best of this scholarship, and come up with a startling picture.
In Latin America, an average of 30.7% of the labor force works in the informal sector, ranging from Venezuela at 26.2% to Bolivia at 44%.
In market-oriented Asian countries, the numbers are relatively low: Hong Kong at 10% and Singapore at 12. 3%. In South Korea, a more heavily regulated and taxed economy, the figure is 20.8%. In more tightly controlled Indonesia, the figure is 39.2%, and in semi-socialist India it’s 47.8%.
Africa has the largest informal sector in the world, ranging from a low of 25.4% in Algeria to an astounding 74.6%-89.8% in Mali.
All data indicate that there has been an enormous shift from formal to informal employment. In Latin America, from 1980 to 1985, formal employment increased 1.2%, public employment increased 4.6%, and informal employment increased 6.8%.
On average, about half of these jobs provide services. Many people are self-employed, many are involved in family businesses, and a surprising number (77% in some developing countries) are in non-paying apprenticeships.
We don’t hear much about apprenticeship anymore, though it is an important and age-old institution. An apprentice does not receive direct pay, but instead gains valuable experience that he can use later. Often he is given room and board, and always he gains a sense of the work ethic and business management.
Our modern era derides apprenticeship as exploitative, even likening it to slavery. But looking at the informal sector, where in some countries apprenticeship is still routine, we see that it is simply a natural way of getting job-specific training. A major portion of informal workers in the third world have no formal education. Apprenticeship fills this need. In fact, informals are much more open to the poor and unskilled than formal markets.
The OECD report notices “an inverse relation between the proportion of employment in the informal sector and the per capita GNP level.” That is to say, the poorer the country, the larger the informal sector. This is not difficult to understand. Poor countries have giant governments, which people attempt to escape, although this explanation seems to elude most economists.
In fact, the informal revolution is ignored by conventional economic theory (i.e., Keynesian and monetarist). You won’t find any mention of it in their texts, and you will never find informalism listed as one of the consequences of interventionism.
Why? Because it requires more than assembling econometric models. To understand informalism, we must take a deeper look at the institutions that give rise to it: excessive regulation, taxation, and other government controls. Economists also dislike the lack of comprehensive statistical data on informals, which seems to place them beyond the reach of study.
Austrian economics, developed most fully by Ludwig von Mises, is unique in focusing on the enduring laws that govern economic behavior. It has the tools to explain why informalism exists (interventionism) and what to do about it (stop intervening).
What hasn’t been noticed is that the informal revolution also casts doubt on the economic data used by economists. When we see figures claiming that some country has 45% unemployment, can they be believed? Probably not. Yet why should officially unapproved economic behavior be considered less legitimate for study than the official kind? It could be that conventional data tell only half the story.
Fortunately, most third-world governments are now less draconian on informalism. Once considered a public menace, informals are spoken of today in more respectful terms. Says the OECD report: “[T]he task of containing the increase in unemployment and absorbing a substantial share of the labour market entrants lies with the informal sector.”
We can go further: informals represent the most powerful empirical repudiation of economic planning by the modem State. Until governments free up their economies, the informal sector will continue to expand beyond its current high levels.
