Informal employment: two contested policy issues.

Abstract: This article addresses two contested issues of crucial importance to policy, namely: formal labour regulations as a cause olin formal employment, and so-called "voluntary" informal employment. The authors provide theoretical overviews on both issues and an extensive survey of empirical studies on the effects of formal labour regulations on informal employment. The article closes with observations on the relevance of the ILO's four decent work objectives for informal employment and economic development, with particular emphasis on the significance of--and potential for--organizing workers in the informal economy.

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There are at least ten publications to date whose titles tell us that informal employment is being "revisited". With so many visits and revisits, one risks a worn out welcome. Yet disaccord persists on such fundamental issues as the causes and quality of informal employment. Against this background, this article addresses two contested issues, both of policy importance: so-called voluntary informal employment, and formal labour regulations as a cause of informal employment.

Perhaps the most essential work on voluntary informal employment is Fields (1990), but the issue has received renewed attention with the contributions of Maloney (1999 and 2004) and his co-authors (e.g. Maloney and Bosch, 2007). The basic idea is that informal employment is heterogeneous, characterized by what Fields calls "easy-entry" and "upper-tier" informal employment, and that "upper-tier" informal employment is "better" than and "preferred to formal sector employment" and is "voluntary" (Fields, 1990, pp. 50 and 66). Voluntary informal employment poses a challenge to conceptions concentrating on "easy-entry" informal employment. Maloney suggests that it also poses a challenge to the ILO's definition of decent work. He writes: "This view of the voluntary informal entrepreneur has important implications for how we think about good vs. bad jobs, 'unprotectedness' and precariousness. The International Labour Organization, for instance, defines 'decent' work as jobs covered and protected by formal labour institutions" (2004, p. 1159).

Yet in its last major report on informal employment, the ILO also emphasized the heterogeneity of informal employment in a manner consistent with the notion of voluntary informal employment:

 
   Increasingly, "informal sector" has been found to be an inadequate, 
   if not misleading, term to reflect these dynamic, heterogeneous and 
   complex aspects of a phenomenon which is not, in fact, a "sector" 
   in the sense of a specific industry group or economic activity 
   [...] There is no simple relationship between working informally 
   and being poor, and working formally and escaping poverty (2002, 
   pp. 2-3). 

The implication is that some informal workers are not in poverty and that some formal workers are, and therefore that some informal jobs are better than some formal jobs with respect to incomes. So it is unremarkable that some workers would prefer informal to formal work, and that is what is meant in these debates by voluntary informal employment. The question is not whether there exists some voluntary informal employment in developing countries, but rather how widespread it is and how this might vary for countries at different levels of development and for different workers, particularly men and women. Among the policy issues at stake are the coherence of endeavouring simultaneously to increase formal employment while improving conditions for informal workers, as well as how the constrained choices informal workers face might be expanded.

Reducing informal employment has been a persistent challenge of economic development and remains a primary policy objective for the ILO. One of the ILO's defining policy instruments is labour regulation, based on ILO Conventions and Recommendations. Yet, an influential view is that labour regulation is itself an important cause of informal employment, implying that the ILO's means contradict its ends. A noteworthy example is the World Bank volume Informality: Exit and Exclusion (Perry et al., 2007), surveying empirical studies that purportedly provide evidence for this view.

One counter to this view is that it focuses unduly on unintended negative consequences and does not give due weight to the extent to which labour regulations fulfil their intended objectives. It is a point worth making, but policymakers need to know if labour regulations have unintended negative consequences, both to make informed decisions in the face of trade-offs and, if possible, to better the design and implementation of labour regulations. In this spirit, this article provides a brief discussion of theories addressing formal labour regulations as a cause of informal employment and then an alternative reading of the empirical literature.

The article addresses these contested issues in two parts, each with its own short conclusion, and closes with observations on the relevance of the ILO's four decent work objectives for informal employment, including the role of organized labour.

"Voluntary" informal employment

Informal employment is a defining issue of development economics. Lewis's (1954) seminal paper in this field presents a familiar picture of urban informal employment even though his paper predated such terminology:

 
   The phenomenon [of "disguised" unemployment] is not, however, by 
   any means confined to the countryside. Another large sector to 
   which it applies is the whole range of casual jobs- the workers on 
   the docks, the young men who rush forward asking to carry your bags 
   as you appear, the jobbing gardener ... petty retail trading (p. 
   141). 

These are Lewis' examples of self-employment. For wage employment, Lewis wrote, "most important [...] is domestic service" (1954, p. 142).

Informed by their research in sub-Saharan Africa, Harris and Todaro (1970) developed a formal model of labour market dualism. (1) The Harris-Todaro model provides an account of why the number of rural to urban migrants could exceed the number of available urban jobs, resulting in open urban unemployment. In this model, entry-level urban wages are "politically determined" above both agricultural earnings and a hypothesized market-clearing level. In this setting, the authors write: "The distinguishing feature of this model is that migration proceeds in response to urban-rural differences in expected earnings ... with the urban unemployment rate acting as an equilibriating force on such migration" (Harris and Todaro, 1970, p. 126). (2)

Though the Harris-Todaro model did not address informal employment, it nonetheless provided the foundation for subsequent theories of informal employment. Fields (1975) extended the Harris-Todaro model in several directions, most relevantly by incorporating an urban informal sector. Employment in this sector is characterized as "underemployment", an alternative to open unemployment for rural migrants unable to find work in the urban formal sector.

All three contributions share the perspective that unemployment, underemployment and informal employment are undesirable and that development policies should aim to minimize them. At the same time, the heterogeneity of informal employment was not just recognized but indeed emphasized in the earliest studies referring explicitly to an "informal sector". Of urban Ghana, Hart wrote: "In practice, informal activities encompass a wide-ranging scale, from marginal operations to large enterprises" (1973, p. 68). Of his typology of informal activities, Hart wrote that it "serves to illustrate the range of income opportunities widely available to the urban sub-proletariat" (ibid., p. 69).

Fields (1990) built on such observations as well as his own research in urban Costa Rica and Malaysia, developing the idea of dualism within urban informal employment characterized by "easy-entry" and "upper-tier" informal employment. Fields found that many upper-tier informal workers had previously worked in formal employment, where they had gained the skills and savings to set up their own informal enterprises. Though Fields emphasizes that upper-tier informal employment is "voluntary", he also refers to its "constrained voluntary nature", elaborating that "given the constrained choices available to them, a great many of informal sector workers are in that sector voluntarily" (1990, p. 67).

Maloney's (2004) description of voluntary informal employment is similar to Fields' in many respects, but differs in emphasizing formal social protection both as a defining characteristic of formal employment and for its role in creating incentives to work informally. For example, in a scenario in which an entire family is eligible for medical benefits as long as one member is formally employed, there is weaker incentive for additional members to be formally employed. This is based on the assumption that workers pay for these benefits in some form and that the formal and informal jobs in question are broadly comparable. Another scenario is that workers may eschew mandatory contributions to pension schemes because of their upfront cost relative to uncertain future return. More generally, the less efficient the delivery of formal social protection, the weaker the incentive to participate. (3)

While Fields (1990) situates voluntary informal employment in the context of dualism within the informal urban labour market, Maloney (2004) goes further, writing that "as a first approximation we should think of the informal sector as the unregulated, developing country analogue of the voluntary entrepreneurial small-firm sector found in advanced countries" (p. 1159). (4) Maloney does not, however, develop a formal model and so strict parsimony considerations do not come into play, calling into question the usefulness of such a "first approximation". It seems more fruitful to pursue Fields' line of inquiry and consider the relative importance of voluntary versus involuntary informal employment and the implications and determinants of this relationship.

The policy implications are of first importance. For instance, the higher the ratio of voluntary to involuntary informal employment:

1. The less meaningful is informal employment as an indicator of a decent work deficit and underdevelopment more generally.

2. The more meaningful is the open unemployment rate as an indicator of labour market slack, with attendant implications for macroeconomic policies.

3. The more contradictory may be policies aiming to increase formal employment while simultaneously improving conditions for informal workers. (5)

There are also research and data implications. (6) For instance, Fields argues that studies that do not account for such dualism within informal employment are "rendered dubious, if not downright invalid" (1990, p. 50). He criticizes the ILO's and other definitions of informal employment in this regard: "One is hard-pressed to see how these working definitions of the informal sector conform to earlier notions based on free-entry" (1990, p. 64). (7) Yet measuring voluntary informal employment is intrinsically thorny, for it requires knowing not just the characteristics of the informal job in question (as per existing definitions), but the characteristics and availability of the formal jobs the worker is qualified for as well as the worker's qualifications themselves. We will return to this point.

Much of the evidence on voluntary informal employment comes from Latin America; in Maloney's case, from Argentina, Brazil and especially Mexico. These three countries have micro panel data, enabling one to trace the movement of workers between formal and informal employment. Yet these are among the most developed of developing countries, raising the question of how meaningful their findings are for poorer developing countries and regions. Fields (2005a) makes this point in reference to Maloney's work: "Perhaps most informal entrepreneurs are in the upper-tier in Mexico, but I doubt this is the case in India, Bolivia and Kenya" (p. 25). (8) Supporting this view, for example, are the findings of a study on Cote d'Ivoire, estimating that about twice as many urban workers want to work in formal employment than actually do, and that about three times as many urban workers are in the lower tier of informal employment than want to be (Gunther and Launov, 2006).

Indeed there are several reasons to suspect that there might be a generally positive relationship between the ratio of voluntary to involuntary informal employment and levels of economic development. More developed countries generally have stronger unemployment insurance systems, and thus open unemployment can more readily …