Posted: Thursday, May 13, 2021. 10:42 am CST.
By Aaron Humes: A study by the World Bank Group published this week finds that an “informal sector” accounts for more than 70 percent of total employment—and nearly one-third of GDP— in emerging market and developing economies (EMDEs). That scale diminishes these countries’ ability to mobilize the fiscal resources needed to bolster the economy in a crisis, to conduct effective macroeconomic policies, and to build human capital for long-term development.
The Bank says this challenge is likely to hold back the recovery in these economies unless governments adopt a comprehensive set of policies to address the drawbacks of the informal sector.
The study, The Long Shadow of Informality: Challenges and Policies, is the first comprehensive Bank analysis examining the extent of informality and its implications for an economic recovery that supports green, resilient and inclusive development in the long-term.
Government revenues in EMDEs with above-average informality totaled about 20 percent of GDP—five to 12 percentage points below the level in other EMDEs. Government expenditures also were lower by as much as 10 percentage points of GDP. Similarly, central banks’ ability to support economies is constrained by the underdeveloped financial systems associated with widespread informality.
It affects mainly women and young people who lack skills as they are left behind without recourse to social safety nets when they lose their jobs or suffer severe income losses, according to a World Bank official. High informality undermines policy efforts to slow down the spread of COVID-19 and boost economic growth. Limited access to social safety nets has meant that many participants in the informal sector have neither been able to afford to stay at home nor adhere to social-distancing requirements. In EMDEs, informal enterprises account for 72 percent of firms in the services sector.
High levels of informality generally mean weaker development outcomes. Countries with larger informal sectors have lower per-capita incomes, greater poverty, greater income inequality, less developed financial markets, and weaker investment and are farther away from achieving the goals of sustainable development.
Informality in EMDEs varies widely across regions and countries—as a percentage of GDP, it is highest in Sub-Saharan Africa, at 36 percent, and had been on a declining trend for three decades before the COVID-19 pandemic. Between 1990 and 2018, on average, informality fell by about 7 percentage points of GDP to 32 percent of GDP. In Latin America and the Caribbean, and the Middle East and North Africa, heavy regulatory and tax burdens, and weak institutions have been important factors in driving informality.
The study provides five general recommendations for policymakers in EMDEs: first, take a comprehensive approach—because informality reflects broad-based underdevelopment and cannot be tackled in isolation; second, tailor measures to country circumstances because the causes of informality vary widely; third, improve access to education, markets, and finance so that informal workers and firms can become sufficiently productive to move to the formal sector; fourth; improve governance and business climates so the formal sector can flourish; and fifth, streamline tax regulation to lower the cost of operating formally and increase the cost of operating informally.
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