Research & Policy Briefs Public Disclosure Authorized From the World Bank Malaysia Hub No. 20, December 2018 Informality: Why Is It So Widespread and How Can It Be Reduced? Norman V. Loayza In a typical developing country, about 70 percent of workers and 30 percent of production are informal. Informality is a cause and a consequence of the lack of economic and institutional development. It implies productive inefficiency and a culture of evasion and noncompliance. Informality, however, exists because it offers the advantages of flexibility and employment in economies with low labor productivity and an excessive regulatory burden. Under these conditions, if there were no informality, there would be greater unemployment, poverty, and crime. A well-conceived formalization strategy should seek to make formality more attractive. As the causes of informality are complex and interrelated, the reforms to reduce it must include all relevant areas. A formalization strategy should consist of making labor markets flexible, reforming social protection, increasing labor productivity, making the regulatory framework and the justice system efficient, and rationalizing the tax system. Public Disclosure Authorized What Is Informality and Why Does It Exist? labor legislation, does not pay income taxes, or performs subsistence activities (ILO 2018). In the second area, a key measure of the size of the informal economy "Informality" is a term used to describe the set of firms, workers, and activities that is the percentage of the country's production that is generated informally (Medina operate outside the legal and regulatory framework or outside the modern and Schneider 2018). economy (Loayza 2016). Informality thus denotes two aspects, one related to noncompliance and evasion of State rules, and the other related to the Informality is widespread in developing countries. It is one of the most precariousness and isolation of informal activity (Perry et al. 2007). Although important characteristics of their labor and production markets. In the typical informality can occur in the range that goes from legally constituted companies to country, the informal sector employs about 70 percent of the labor force and workers in subsistence activities, it is more prevalent in smaller firms, more produces around 30 percent of GDP. There is, however, considerable heterogeneity marginal locations, more rudimentary activities, and among less educated people across and within regions (see figure 1). Informal labor is highest in Sub-Saharan (Perry et al. 2007; ILO 2018). Africa and South Asia (with medians across countries in each region of around 90 percent of the labor force); still considerably high in East Asia and Pacific, Latin Informality is both a cause and a consequence of the lack of economic and America and the Caribbean, and Middle-East and North Africa (with regional institutional development (Schneider and Enste 2000; Oviedo, Thomas, and medians of 60 to 65 percent); lower in Eastern Europe and Central Asia (regional Karakurum-Özdemir 2009; Kose, Ohnsorge, and Yu forthcoming). It is a problem median of nearly 30 percent); and lowest in the rich countries of the OECD (group because it implies that a large number of people and a considerable share of median of just over 10 percent). Informal production as a share of GDP is also economic activity do not fully benefit from appropriate technologies and efficient substantial in developing countries, though lower than in terms of employment, a production methods, access to essential public services such as police and judicial reflection of the informal sector´s lower productivity (see below). protection, and the possibility of sharing and mitigating risks such as old age, Public Disclosure Authorized illness, and unemployment. Informality is also a problem because informal firms, Informality is persistent over time. In many countries, however, the trend, workers, and activities contribute insufficiently to the State and the generation of though high, is declining (see figure 2). Of the 36 developing countries for which public goods. the ILO (2018) reports informal employment for 2005–17, 60 percent have reduced the share of informal employment and 17 percent have done so by more Informality, however, exists because it offers the advantages of flexibility, than 1 percentage point per year. Similarly, of the 134 developing countries for creativity, and employment in economies constrained both by low labor and business which Medina and Schneider (2018) report informal production for 2005–15, 79 productivity and by a State that does not offer efficient services but imposes an percent have lowered the share of the informal sector in total production and 8 excessive regulatory and tax burden. Under these conditions, if there were no percent have done it by more than 1 percentage point per year. informality, there would be greater unemployment, poverty, conflict, and crime. This brief reviews the prevalence of informality around the world; describes The Consequences of Informality its consequences for productivity, growth, and risk diversification; analyzes its Informality brings positive and negative consequences for firms and workers in the causes in terms of lack of economic and social development; and presents a economy (Schneider and Enste 2000). On the positive side, by avoiding the burden strategy to formalize the economy, from objectives to guiding principles and of regulation and taxation, informal sector enterprises enjoy more flexibility in specific reforms. personnel decisions, location, resource management, and market competition. Thus, informal firms and workers are often characterized by their dynamism and How Prevalent Is Informality around the World? creativity (De Soto 1988). From a social perspective, no less important is the fact The informal economy is commonly defined and measured in relation to two that the informal sector fulfills the function of generating employment, especially areas: employment and production. In the first area, a key measure is the during economic recessions (Fiess, Fugazza, and Maloney 2007; Loayza and percentage of employment that is not subject to or does not comply with Rigolini 2011; Kose, Ohnsorge, and Shu forthcoming). Public Disclosure Authorized Figure 1. Informal Labor and Informal Production by Region a. Informal labor as a share of total employment, 2016 b. Informal production as a share of total GDP, 2015 100 100 90 90 80 80 70 70 Percent Percent 60 60 50 50 40 40 30 30 20 20 10 10 0 0 OECD EAP ECA LAC MENA SA SSA OECD EAP ECA LAC MENA SA SSA Source: For panel a, ILO (2018) and Loayza and Meza-Cuadra (2018); for panel b, Medina and Schneider (2018). Note: OECD includes high-income countries that have been members of OECD for more than 40 years. Other regions include East Asia and Pacific (EAP), Europe and Central Asia (ECA), Middle East and North Africa (MENA), Latin America and Caribbean (LAC), South Asia (SA) and Sub-Saharan Africa (SSA). Affiliation: Development Research Group, the World Bank. Acknowledgement: Daniel Barco, Ximena Del Carpio, Sharmila Devadas, Cristina Fernández, Carlos Ganoza, Pedro Herrera-Catalán, Leonardo Iacovone, Ayhan Kose, William Maloney, David McKenzie, Claudia Meza-Cuadra, Gioconda Naranjo, Ana María Oviedo, Mónica Parra, Nelson Ramírez-Rondán, Jamele Rigolini, Juan Sebastián Robledo, Marc Schiffbauer, Achim Schmillen, Luis Servén, Nurlina Shaharuddin, Laura Tamayo, Alfredo Thorne, Shu Yu, Gabriel Ulyssea, Tomoko Utsumi, and the teams of Peru´s Consejo Nacional de Competitividad y Formalización and Colombia´s Consejo Nacional de Política Económica y Social contributed with insights, comments, and suggestions to this brief. Nancy Morrison provided editorial assistance. Objective and disclaimer: Research & Policy Briefs synthesize existing research and data to shed light on a useful and interesting question for policy debate. Research & Policy Briefs carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions are entirely those of the authors. They do not necessarily represent the views of the World Bank Group, its Executive Directors, or the governments they represent. Informality: Why Is It So Widespread and How Can It Be Reduced? Figure 2. Decrease in Informality in Relation to Economic Growth and Formalization Reforms, circa 2005-2015 2.0 5.0 Decrease in informality (percentage points, annualized) 4.5 Growth rate of GDP per worker (percent) 4.0 1.5 3.5 3.0 1.0 2.5 2.0 1.5 0.5 1.0 0.5 0.0 0.0 -0.5 -1.0 -0.5 -1.5 -2.0 -1.0 -2.5 Zambia Belarus Georgia Rwanda Sri Lanka Haiti Zimbabwe Madagascar Tanzania Cambodia Poland Angola Philippines Benin Nepal Bangladesh Uganda Morocco Malaysia Tunisia Ukraine Oman Yemen, Rep. Botswana India Indonesia Mexico Algeria Kenya Venezuela, RB Central African Republic Uruguay Thailand Peru Turkey Colombia Vietnam Chile Pakistan Dominican Republic Ecuador Brazil Côte d’Ivoire Guatemala Ghana South Africa Russian Federation Egypt, Arab Rep. Informal labor as a share of employment Informal production as a share of GDP Growth of GDP per worker Strong reforms Moderate reforms Weak reforms Lacking reforms Source: Author’s calculation based on ILOSTAT (2018), TURKSTAT (2018), and Medina and Schneider (2018) for informal labor and production; World Bank World Development (2018) for growth of GDP per worker; Kim and Loayza (2018) for market flexibility and governance; World Bank ASPIRE Indicators (2018) for social protection; and World Bank Doing Business (2018) for taxes. Note: Reforms are measured using indicators in the areas of market flexibility, social protection, governance, and taxation. Considering the period 2005−15, progress of at least 10 percent in three or four areas is labeled “Strong”; in two areas, “Moderate”; in one area, “Weak”; and in no area, “Lacking.” Growth rates are truncated at −2.5 percent and 5 percent. On the negative side, firms in the informal sector suffer the costs and risks of are relevant, in proportions that vary from country to country. For example, not having the protection and services that the law and the State can provide (for examining the higher labor informality in Peru compared to Chile, Loayza and instance, protection by the police against crime or by the judicial system against Wada (2010) estimate that 75 percent of the difference is due to causes related to breach of contracts). This results in high levels of inefficiency as most informal poor governance and the remaining 25 percent to structural causes of low enterprises remain small, have limited access to banking services, use irregular productivity. In contrast, when comparing the higher informality in Indonesia to channels to acquire and distribute their goods and services, and must spend the lower level in the Republic of Korea, they find that 75 percent of the difference additional resources to cover up their activities (La Porta and Shleifer 2014). Figure is explained by factors related to lower productivity. 3 provides a rough estimation of labor productivity in the informal sector for a large group of countries. For most of them, informal productivity is between 25 One way to appreciate that both lack of economic development and poor and 75 percent of total labor productivity in the economy—and informal governance can be responsible for the high level of informality in a country is to productivity decreases as informality rises. consider the international relationship between informality and per capita income (see figure 4). The comparison shows that less economically developed countries For workers, informal employment, although it is generally preferable to tend to exhibit larger informality. However, some countries have a significantly unemployment, often involves poor working conditions and restricted access to higher level of informality than their level of GDP per capita would predict. This social protection. Informal employment is characterized by the possibility that the suggests that informality is not only driven by economic development but also by agreed wages will not be paid, the obligation to do overtime or extraordinary other idiosyncratic factors, arguably connected to the quality of government and shifts, dismissals without notice or compensation, an unsafe working regulatory environment. Take, for example, the case of Nigeria. Its fraction of environment, and the absence of benefits such as retirement pensions, or health informal workers in total employment is about 90 percent, that is, over 20 and unemployment insurance (Oviedo, Thomas, and Karakurum-Özdemir 2009). percentage points higher than what could be expected according to its income level; In Colombia, for instance, informal salaried and self-employed workers are and the fraction of informal production in GDP is 50 percent, also 20 percentage generally more dissatisfied with their jobs than their formal counterparts, points larger than expected. In other regions, excessive labor informality can be particularly regarding fringe benefits (Perry et al. 2007). identified in India, Indonesia, Peru, and Qatar; while excessive production informality can be detected in Haiti, Georgia, Myanmar, Thailand, and Zimbabwe. At the social level, the informal sector generates a negative externality because informal activities use and congest public infrastructure without Objectives of a Formalization Strategy contributing the necessary tax revenues to fund it (Loayza 1996; Johnson, Kauffman, and Shleifer 1997). In many countries, tax evasion can be substantial. Before a strategy to formalize the economy can be designed, its long-term objectives For Ghana, for instance, Danquah and Osei-Assibey (2018) calculate a tax gap of should be clear. In principle, formalization should achieve the following goals: about 70 percent (the difference between actual and potential revenue collected from the informal sector). 1. Increase the productivity of workers, businesses, and the economy in general. The transition from informality to formality can represent a substantial efficiency The Causes of Informality gain (see figure 3). This is realized as firms grow in scale and diversity, adopting new technologies, inducing workers to collaborate with complementary skills, and There are two main schools of thought about the causes of informality (Schneider reaching new domestic and foreign markets. Moreover, an expansion of the tax and Enste 2000; Loayza 2016). The first considers that informality is a symptom of base can imply larger and more stable resources for funding public infrastructure underdevelopment (ILO 2018). Under this approach, the informal economy is the and services. The implication for economic growth can be strong and significant result of low productivity of workers and firms. This is due to structural factors, (Levy 2018; Loayza, Oviedo, and Servén 2006). including lack of physical capital, low educational level, and certain sociodemographic factors (such as a high incidence of young and rural 2. Reduce the vulnerability to systemic and idiosyncratic risks. The reforms that populations). According to this perspective, policies to reduce informality should be bring about formalization can not only lead to greater economic growth but can aimed at increasing labor and business productivity (La Porta and Shleifer 2014). also increase the ability of the national economy, firms, and workers to adjust to the changing conditions of the world economy, to recover from adverse shocks, The second school of thought considers that informality is the result of bad and to avoid unnecessary risks to health and safety (World Bank 2013). The governance. Thus, informality is the response of the private sector to an overly combination of market flexibility with broad and effective social protection regulated economy and an inefficient State (De Soto 1988). Under this approach, encourages formalization and decreases vulnerability. firms choose to operate within the informal sector when the costs of complying with regulations exceeds the benefits from accessing public services offered to 3. Promote a culture of respect for law and order. Formalization requires improving formal companies. If informality is the result of poor governance, policies should the legal and regulatory systems. This can help economic agents change their focus on improving the regulatory environment and public services (Djankov et al. perspective and behavior with respect to laws and regulations, as well as the 2002). institutions responsible for enforcing them. If economic agents see these institutions as reasonable and fair, they will perceive a clear personal and social Both schools of thought are correct. Informality should be understood as a benefit in respecting them. Moreover, the reforms entailed in a formalization complex and multifaceted phenomenon that is not due to a single cause. Lack of strategy can radically reduce the incentives and the possibilities for official 2 economic development (and low productivity in particular) and poor governance corruption and abuse (Friedman et al. 2000). Research & Policy Brief No.20 2014; Bruhn and McKenzie 2014). Concentrating the formalization effort on Figure 3. Informal Labor Productivity Relative to Total Labor microenterprises is misguided. Instead, formalization should be sought through Productivity (2016) the generation of employment and production mainly in emerging, medium, and large firms. These are the enterprises that can generate greater growth in productivity and greater diversification of risks. A healthy economy is Informal labor production as a share of total GDP over Informal 2.25 FIN characterized by the entry of young companies that boost its productivity 2.00 NOR (Haltiwanger, Jarmin, and Miranda 2013; Cirera and Maloney 2017). Dynamic firms, whether new or established, can be the source of formal jobs if the labor as a share of total employment 1.75 HRV HUN BLR KAZ conditions are favorable. 1.50 LTU SWE PRT 4. Implement a comprehensive, not a piecemeal, formalization strategy. No policy BEL BGR MDA or isolated reform on its own can bring about a significant reduction in informality 1.25 DNK ITA UKR (Oviedo, Thomas, and Karakurum-Özdemir 2009). To succeed, a formalization FRA CZE 1.00 ISR BIH strategy must include well-integrated reforms that address the complexity and AUT NLD URY ESP GRC RUS GEO particularity of informality in each country. The contribution of each reform can 0.75 DEU IRL HKG ROU KWT TUR BRA ARM AZE THA SLV ZWE HTI enhance and complement the positive effect of the rest, so that the benefit of CHE AUS SVK CAN GBR KOR ZAF MYS OMN KGZ MEX TUN LBY PERTJK NIC GTM BOL MMR NGA CAF COD BEN implementing a comprehensive formalization strategy can be greater than the ARG 0.50 JPN SGP SAU QAT CRI POL DOM DZA ECU EGY ALB LBN PHL LKA PRY YEM MAR HND KEN LBR COG GIN GHA MDGUGA CIV BDI sum of the isolated effects of its components. Integration of reforms may be LSOPNG TGO 0.25 USA CHL JOR MNG COL BWA IRN JAM NAM MRT PAK MWI TZA ZMB BGD SEN SLE AGO KHM NPL MLI NERMOZBFA necessary not only for these technical reasons but also for political economy CMR CHN VNM IDN IND LAORWA TCD considerations: reforms may be more socially acceptable as a package than as 0.00 piecemeal. The countries whose economies have formalized the most in the last 0 10 20 30 40 50 60 70 80 90 100 decade are those that have implemented extensive reforms and/or grown rapidly Informal labor as a share of total employment (percent) (see figure 2). EAP ECA LAC MENA OECD SA SSA Reform Components of a Formalization Strategy Source: Author’s calculation based on ILO (2018), Loayza and Meza-Cuadra (2018), and Medina and Schneider (2018). The main reform components of a formalization strategy can be grouped into five Note: Data labels use the International Organization for Standardization (ISO) country large areas. With different degrees, all of them seek to confront the two main codes. OECD includes high-income countries that have been members of OECD for more causes of informality –lack of development and poor governance—and to make than 40 years. Other regions include East Asia and Pacific (EAP), Europe and Central Asia formality attractive in a comprehensive yet realistic way. (ECA), Middle East and North Africa (MENA), Latin America and Caribbean (LAC), South Asia (SA), and Sub-Saharan Africa (SSA). 1. Make the labor market more flexible. In an economy with a large and growing workforce, it is essential that the labor market has the capacity to generate Guiding Principles of a Formalization Strategy enough formal employment opportunities. To do this, labor markets must be flexible to adjust to changing conditions in labor supply (including the numbers, Before defining the specific reforms that compose a formalization strategy, the skills, and demographic profiles of workers) and in labor demand (such as principles underlying these reforms should be presented. These principles consider technological innovations and preference changes that induce sectoral production the fundamental causes and most relevant consequences of informality, the shifts and entry and exit of firms) (Caballero et al. 2013). Companies must retain prevalence and size of the informal economy, and the objectives to be achieved the ability to determine their workforce without major restrictions on hiring and through formalization. The guiding principles should include the following: firing. Likewise, the wage and nonsalary costs that firms face must correspond to 1. Reduce informality, but not at all costs or in any possible way. An indiscriminate the productivity of workers and market conditions, rather than mandated wages reduction of informality can lead to unemployment, poverty, and the social evils and benefits introduced without a clear economic rationale. Once the labor they bring, from criminality to social conflict (Fernandez et al. 2017). These market is flexible, the enforcement of regulatory compliance should be effective alternatives are clearly inferior to informality. Informality has existed in the labor and directed to both formal and informal employment, with an emphasis on markets of developing countries in symbiosis with the rest of the economy, to the health and safety in the workplace. point that it can be regarded as “normal" (World Bank 2012). This condition can 2. Reform social protection. Labor flexibility can be politically and socially viable and should be improved, without losing the benefits it has brought to economic only if it is accompanied by labor reinsertion systems and encompassing social activity and people’s welfare. protection aimed at the worker, regardless of employment status. The 2. Make formality attractive, rather than only penalize informality. The strategy amalgamation of labor flexibility, social protection, and labor reinsertion amounts should emphasize the positive aspects of formalization, making formality more to a new social pact, best exemplified by the Danish flexicurity system (World Bank attractive. It should, therefore, seek to increase the benefits of formality and 2013). There is a vicious circle between poorly designed social protection and high reduce its costs, as well as discourage informality: that is, a series of “carrots” informality: Payroll taxes imposed to fund social protection programs (for health alongside “sticks” can be adopted, depending on the characteristics of a country’s care and retirement pensions, for instance) make formal labor expensive and informal sector (Oviedo, Thomas, and Karakurum-Özdemir 2009). Enforcement of generate informality; in turn, informality implies low coverage of social protection rules and regulations is important, of course, but only to the extent that they are programs; and the response to low coverage is to establish parallel noncontributory economically and socially sensible. Moreover, enforcement should be directed to systems, which further encourage informality (Levy 2008; Maloney 2004). This both formal and informal firms and activities–monitoring and supervision only of vicious circle must be broken. Social protection reform can not only help in formal firms tilts the playing field and discourages formality. achieving its primary objectives but also contribute to formalization of workers and enterprises. It must be based on the following principles: it should benefit people 3. Formalize labor and economic activity, not necessarily all firms. The vast regardless of employment status; target the most vulnerable; be fiscally viable; and majority of microenterprises in heavily informal economies are inefficient and not discourage self-sufficiency (World Bank 2013). Although the optimal design can would gradually exit the market as development proceeds (La Porta and Shleifer vary according to social preferences and resources, social protection programs Figure 4. Informal Labor and Informal Production versus GDP per capita b. Informal labor as a share of total employment, 2016 a. Informal production as a percent of GDP, 2015 UGA TCD 100 MOZ MLI RWA BEN KHM LAO NGA AGO 70 CAF NER BDI SLE NPL CIV HTI GIN SEN GHA IND IDN ZWE 90 COD MDG BFA BGD LSO CMR PNG TGO AFG MMRZMB COG 60 LBR TZAZWE BOL MWI PAK KEN HND MAR 80 MRT NIC GTM YEM LKA HTI TJK VNM SDN JAM PER 70 PHL LBN 50 NGA GEO SLVPRYIRQ NAM CAF MMR PSE THA BWA AZE BEN COD 60 EGY GEO LBY IRN COL MDG GIN NIC BOL GTM THA ALB MEX LBR SLV PER TUN MNG ECU AZE DOM 40 TZA CIV UKR ARM Percent Percent PAN TJK GHA HND MDACOG BRA CHN ARG SEN 50 ARMDZA NER SLE KEN LKA LBY BLR BRA KHM LSO PNG AGOPRY RUS KGZ MYS CHL OMN BDI MWI MOZ NPL UGA PAK ZMB EGY KAZ 40 JOR 30 TGO MLI KGZ PHL TUN BIH LBN MEX YEM CMR ECU TUR GRC CRI POL GRC BFA TCD MAR ALB DOM ARG MYS ZAF RUS TUR RWA BGD HRV ESP MRT LAO JAM COL OMN ARE 30 UKR BIH ROU KOR KWT ETH IDN NAM DZA BWA ROU URY HUN KOR MDA MKD SAU ESP QAT 20 ZAF BGR LTU ITA SVN KWT BEL SRB ITA JPN IND CRI DNK QAT URY SGP IRN ISR 20 BLR KAZ ISR USA JOR POL PRT HKG FRA LTU GBR MNG CHL SWE BGR CAN VNM SAU NLD NOR HUN SVK HKG NLD IRL 10 CAN FIN SGP PRT FRA BEL AUT DNK CHN SVK NZL 10 HRV CZE GBR JPN AUT IRL CZE DEU AUS CHE NOR DEU AUS CHE SWE USA SVN FIN 0 0 5 6 7 8 9 10 11 5 6 7 8 9 10 11 ($150) ($400) ($1,000) ($3,000) ($8,000) ($22,000) ($60,000) ($150) ($400) ($1,000) ($3,000) ($8,000) ($22,000) ($60,000) GDP 2015, constant 2010 US$ (Logs: upper numeral. Absolute value: lower numeral) GDP 2015, constant 2010 US$ (Logs:upper numeral. Absolute value: lower numeral) EAP ECA LAC MENA OECD SA SSA Source: For panel a, ILO (2018); Loayza and Meza-Cuadra (2018); for panel b, Medina and Schneider (2018). Note: Data labels use the International Organization for Standardization (ISO) country codes. OECD includes high-income countries that have been members of OECD for more than 40 years. Other regions include East Asia and Pacific (EAP), Europe and Central Asia (ECA), Middle East and North Africa (MENA), Latin America and Caribbean (LAC), South Asia (SA), and Sub-Saharan Africa (SSA). 3 Informality: Why Is It So Widespread and How Can It Be Reduced? should feature two components: universal basic coverage (mostly funded with 5. Rationalize the tax system. The tax system has two primary objectives. The first general taxes) and complementary coverage (funded through voluntary is the collection of the necessary resources for the State to provide public goods contributions for supplementary benefits). and services to society, such as infrastructure, education, justice, and social protection. The second is that the collection of taxes should not be obtained at the 3. Increase labor productivity. The demand for formal workers depends not only expense of economic efficiency, by introducing distortions and unwarranted on their costs or the ease of hiring and firing, but also on the productivity of incentives or disincentives to particular activities. A poorly designed tax system workers and firms (Maloney 2004). At the individual level, labor productivity can represent a barrier to investment and growth and can induce evasion and depends on the technical and social skills acquired at home and school. Educational reform—from better school infrastructure to improved teachers’ informality. To promote formalization, the tax system should tend toward incentives and more suitable curriculum—is badly needed to transform schooling simplicity, gradual increases in the tax cost with the size of the firm (so as not to into learning (World Bank 2018). For workers already in the labor force, retraining discourage growth), and reduction of marginal tax rates (to encourage investment to adjust to changing market conditions is necessary to sustain and improve their and employment in growing and large companies) (OECD 2004). Value added productivity (Card, Kluve, and Weber 2018). For those who have lost their jobs, taxes (VAT) have proven to be strong tax collection mechanisms. They can also labor reinsertion systems, including orientation and retraining, are needed in a promote formality by creating a chain between inputs purchases and outputs timely way to prevent the harmful consequences of prolonged unemployment. At sales that encourages tax payment. To strengthen this mechanism, VAT the firm level, labor productivity depends on the quality of management, the exemptions should be kept to a minimum, if not eliminated altogether, and usefulness of capital investment, and the capacity to adopt and develop new enforcement maintained throughout the value chain (De Paula and Scheinkman technologies, processes, and products (Cirera and Maloney 2017). Finally, at the 2010). Finally, the tax enforcement agency must be made more efficient through economy-wide level, labor productivity is also determined by the quality of public the use of information technologies and address not only formally registered firms infrastructure and government institutions, as well as competition in and access to but also informal activity. global markets (Kim, Loayza, and Meza-Cuadra 2016). It is not surprising, then, that one of the positive consequences of sustained economic growth is the From Strategy to Plan and Implementation gradual formalization of the economy (McCaig and Pavcnik 2015) (see figure 2). The strategy presented above contains the principles but not the specific 4. Make the regulatory framework and the justice system more efficient. The measures that are needed for a concrete plan. These must be country specific regulatory framework should promote business development, market (Fernandez et al. 2017; Campos, Goldstein, and McKenzie 2018). For each reform competition, and the protection of workers and consumers. An outdated or component, first, a diagnosis of the country´s current situation is required, inadequate regulatory framework can, on the contrary, be an obstacle to growth possibly contrasting it with other countries; and, second, specific reforms to and formality (Loayza, Oviedo, and Servén 2006). For instance, regulations that address the main weaknesses should be formulated. favor small firms can stunt growth and induce informality (Dabla-Norris et al. These reforms would consist of a combination of measures that vary in terms 2018). To promote formalization, the regulatory framework must be simple, clear, of their economic cost, technical complexity, and political difficulty: From and modern at all stages of the firm's life, from its formation to its exit from the relatively straightforward procedural improvements (modernizing the regulatory market (Friedman et al. 2000; Divanbeigi and Ramalho 2015). The modernization environment), to more difficult executive measures (justice system reform), to of the regulatory framework must involve the use of new information politically challenging legislative changes requiring popular support (labor market technologies and the constant refinement of all institutions involved in regulatory and social protection reforms). In addition to specific and well-grounded processes, including central and local governments. Likewise, the justice system measures, for implementation to succeed, a formalization plan should explicitly can have a direct impact on formality, making formality not only attractive but also state the costs and difficulty (procedural, budgetary, and political) of each reform; feasible. Formality is often constrained by the lack of legally recognized ownership a timeline for their realization and potential effects; and the entities responsible and usage rights over urban and rural land (De Soto 1988), with highly polluting for their execution, monitoring, and evaluation. informal mining and indiscriminate and disorganized city growth as two palpable examples. What is needed is a consistent and agile justice system that lays the Formalizing the economy without losing the advantages of flexibility and rules for property and use of the territory, resolves commercial and labor employment is a task of epic proportions. It is, nonetheless, feasible provided policy disputeseffectively, enforces contractual agreements fairly, and protects citizens makers possess sufficient expertise and, above all, political will. The long-term from crime and predatory behavior. benefits of formalization for growth and prosperity can be vast and enduring. 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