# **1. Introduction**

In 2012, the urban informal sector represented 81.5 percent of employment in the Democratic Republic of Congo (World Bank 2016). This large proportion highlights the sector’s critical importance for job creation and income growth in the country. The sector is also vital for the achievement of the twin goals of poverty reduction and shared prosperity, as it tends to offer opportunities to the most vulnerable, namely, the poorest, women, and youth. While the informal sector is defined in various ways in the literature, it is generally said to encompass economic activities that are not subject to taxes and other regulations (De Soto 1989; Loayza 1996). This paper defines enterprises in the informal sector as enterprises without formal accounting books and national identification numbers as firms. This definition seems more appropriate because it allows for comparability with studies in other developing countries.

Many aspects of the informal economy have been studied. Earlier studies have focused on explaining the reasons underlying the emergence of the informal economy, the productivity of the informal sector, and why firms remain informal. For instance, Johnson, Kaufmann, and Shleifer (1997) and Johnson, Kaufmann, and Zoido-Lobatón (1998) argue that the most striking factors explaining the emergence of informal firms are rigid labor regulations, high registration costs, bribery, and constraints in the delivery of public goods and services. Using data on Latin America, Loayza (1996) finds that the size of the informal sector is negatively correlated with the quality of government institutions and positively correlated with proxies for tax burden and labor market restrictions. Still, little attention has been paid to heterogeneity in the informal sector and even less to inequality within and between the various categories of informal firms. Understanding this heterogeneity and income inequality is crucial to the design of appropriate policies.

This paper contributes to the empirical literature by analyzing heterogeneity in the informal sector in the Democratic Republic of Congo and the implications for the performance of firms and income inequality. Relying on a representative sample of informal firms derived from the 1- 2-3 survey in the country, the paper identifies three distinct groups of informal entrepreneurs: top performers, constrained gazelles, and survivalists. The first group of entrepreneurs is growth oriented and enjoys a greater access to capital. The second group includes entrepreneurs who share many characteristics, especially management skills, with the top performers, but operate with less capital. The survivalists, entrepreneurs who are struggling to grow, represent the third group. Furthermore, the paper makes three other major contributions. First, it analyzes poverty and income inequality among these three distinct categories of firms. Second, using a BlinderOaxaca decomposition, it explains income differences across the three groups. Third, it examines the drivers of performance and profitability among informal firms.

The results highlight a striking heterogeneity among informal firms. Poverty rates are higher among survivalists and constrained gazelles than among top performers. Income inequality, which is more common among constrained gazelles and survivalists, is mainly explained by 2