# **4.2 What Should Be Done about Informality?**

The dominant policy perspective on informality can be illustrated by the following two quotes, the first from the World Bank and the second from The Economist: “There are various reasons why governments may be concerned about large informal sectors. These include potentially negative consequences for competitiveness and growth, incomplete coverage of formal social programs, undermining social cohesion and law and order, and fiscal losses due to undeclared economic activity. For most governments, these concerns outweigh any advantages that the informal sector offers as a source of job creation and as a safety net for the poor.”<sup>2</sup> “Thanks largely to baroque regulation, half the labour force toils in the informal economy, unable to reap the productivity gains that come from technology and greater scale.”<sup>3</sup> Thus it would seem that the informal sector is a “problem” because of (i) low productivity, (ii) low contribution of fiscal resources and (iii) concentration of poverty, vulnerability and exclusion. Further, the major causes of informality are to be found in “baroque regulations.” The headline policy conclusion of the conventional wisdom is thus clear—informality is a problem, it is caused by overly strict regulation of the formal sector, and it can be solved by deregulation. However, we wish to sound a note of caution, especially given the stubborn persistence of informality the world over, even in the face of historically high economic growth rates when regulations have not necessarily been tightened—if anything, they have been relaxed. Yet, job creation in the formal sector has slowed leaving the informal sector to pick up the slack. If these trends continue the informal sector may need to be viewed not as a problem to be solved by “formalization” but as a sector in need of support to enhance the productivity of the poorest members of society.

Our focus in this paper has been not informality per se, but informality in the context of urbanization, and the lack of formalization in the face of rapid urbanization. Our discussion has shown that the persistence of informality is to be expected as urban formal sector jobs expand, since the expectation of securing these jobs pulls in far more migrants from the rural sector than there are formal jobs, with the surplus ending up in the informal sector. We have also shown that from an enterprise based perspective, it can be a perfectly rational response to stay small in size. This can be in response to regulations. But it can also be in response to rising urban density and to changes in technology which make operating at smaller scale less inefficient than was previously the case. If this argument has some validity, then informality caused by smallness of size is unlikely to disappear with urbanization. Indeed it is likely to grow.

The arguments in this paper suggest that caution about the conventional policy perspective is particularly warranted given the fact that the increase in informality in the last two decades has happened alongside rapid urbanization. Research on interaction between urbanization and informality is still at an early stage. Empirical evidence on why some cities attract more informal activity than others is still sketchy. While it is clearly the case that the “cost of doing business” is relevant (Levy, 2007), other factors can also be important. Agglomeration economies may be more important in fact for informal activities than for the 2 <u>http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTSOCIALPROTECTION/EXTLM/0,,contentMDK:20224904~men uPK:584866~pagePK:148956~piPK:216618~theSitePK:390615,00.html</u> Accessed June 28, 2012

> 3 The Economist, September 9, 2010,  http://www.economist.com/node/16990967 Accessed August 26, 2012

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