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Economic Development & The Global Informal Economy

David Epstein

davideps@umich.edu
 

 

Introduction

Commercial activity outside the governmental system responsible for regulating such activity is referred to as "informal". This describes the majority of transactions in the Peruvian, Ethiopian, and Indian economies. Once viewed as a temporary phenomenon caused by globalization, the informal economy is now seen by many economists as a permanent fixture of capitalist development. According to the International Labour Organization (ILO), about 40 million formal jobs are created globally every year and about 48 million new people seek jobs annually. (ILO, 2002:95) The informal economy helps to bridge this gap, especially in the developing world.

source:
"The Informal Economy", SIDA

There is a lively discourse about “what to do with” the informal economy. Some people advocate for doing nothing at all. Those who do advocate for intervention usually do so for either moral or economic reasons. The first group posits that government and civil society have a responsibility to provide the poor with a higher standard of living. The second group recognizes the contribution of informal work to the rest of society (Table I) and seeks to develop the sector economically.

This essay will first provide a general overview of problems encountered by workers and business owners in the informal economy and offer potential solutions. It will then offer a brief case study of SEWA Bank in India to illustrate how such problems and solutions actually function on the ground in a busy city.

Focus Points for Local Economic Development

Before intervening in the informal economy, it is vital to study the local context in detail. Unfortunately, many economists argued that the sector would disappear in time, providing little motivation for governments to

Table I

Contributions of the Informal Economy to Society

(1) Contributes to GDP

(2) Produces a large share of goods used by middle and low-income groups

(3) Provides a training ground for entrepreneurs

(4) Absorbs more unemployed workers than less labor-intensive jobs in the formal sector

  Source: Chen 2/2002

conduct research. Many countries are only now collecting reliable data on the size, diversity, linkages, and demographics of the informal sector. Economic development should mitigate the particular problems revealed through research. Workers in the informal sector can be self-employed or work for someone else and receive a wage. People in different situations face different circumstances. Listed below are common sources of difficulty and potential avenues for related economic development.

Infrastructure
Infrastructure needs vary depending on the nature of the informal business. A street vendor may require selling space and storage facilities; a home-worker needs a house and most likely basic utilities such as water and electricity. In the latter case, local economic development may actually be synonymous with housing upgrading.
Legal Status
Informality, by definition, means that some aspect of a business is vulnerable to intervention by the authorities. For example, home workers without title to their house are in constant jeopardy of also losing their employment should the police take action. People without legal title to their house who work elsewhere frequently fear that it will be seized when they are away. This results in unproductive time spent simply protecting possessions. Programs that improve land tenure can assist these business owners and workers.
 
 
Education & Training
Many informal business owners conduct commercial activity without formal education in mathematics or small business finance. In some countries, the illiteracy rate in the sector is extremely high. Many informal business owners rely on traditional labor-intensive methods and are unaware that other methods exist. Thus, they may not recognize the need for skill building. School programs that teach basic mathematics and financial management to informal business owners can increase the efficiency of their ventures. Furthermore, many trades have traditional apprenticeship programs that can be strengthened. However, improving methods of production may decrease the capacity of the sector to absorb excess labor.
Representation
Unlike the formal business community which benefits from economic development offices, chambers of commerce, and trade associations, informal businesses usually do not have established organizations to represent their interests. Offering organization building assistance and a meeting place can raise local social capital and lead to information sharing, pooling of resources, and economies of scale.
Economies of Scale
Most self-employed businesses employ only a handful of people and stakeholders are not tightly organized. This results in an inability to exploit economies of scale in purchasing raw materials or in production. Yet, there are many such businesses--so the potential exists.
Safety Nets
Workers in the informal economy frequently do not have social security, injury compensation, health insurance, or property insurance. This leaves them unprotected from a myriad of common risks. Offering special programs to workers in the informal sector may serve to stabilize businesses in times of need.
Employment Standards
Wage workers in the informal sector are frequently not subject to minimum wage or to minimum health and safety regulations. This is a controversial issue since strict enforcement of wage standards in particular may cause some informal businesses to close. Providing financial assistance to raise health and safety conditions to code may prove helpful.
Financial Services
Standard banking schemes often require minimum balances and do not offer financial products or business services that cater to the hours and lifestyle of people in the informal sector. Workers in the informal sector are dependent upon private money loaners who charge exorbitant interest. Flexible and custom banking systems are necessary to serve the informal sector.
Market Knowledge
Informal sector workers suffer from poor information about both supply and demand markets. They may be unaware of available raw materials and unsure how to locate dependable markets for their own products. Meeting demand expectations may prove difficult because of unfamiliarity with recognized standards. Improving representation and general education may improve market knowledge as would guidance from specialized governmental agencies or non-governmental organizations. For example, in India, both public and private entities have worked together to develop domestic and foreign demand for traditional handicrafts and simultaneously guided the burgeoning informal craft sector. (Chen 2002)
 

Barriers to Formalization

Formalization is the process by which an informal business becomes fully legal under the law. This usually requires firms that exist in a day-to-day state of flexibility and change to interact with the more rigid apparatus of government. Corruption can cause acute problems since informal business owners are frequently in a vulnerable position. As the table to the right indicates, starting a business is frequently slower, more expensive, and more difficult in some of the very same countries with high rates of informal employment such as Peru and Ethiopia. There are numerous steps toward formalization--and thus gradients to informality.

The process must provide tangible benefits to business owners. If it does not, many will choose to avoid the additional burdens of regulation and taxation that come with legality.

source:
"The informal Economy", SIDA

Case Study: SEWA and SEWA Bank

image source: sewabank

Background

The Self Employed Women's Association (SEWA) was registered as a trade union in the state of Gujarat, India in 1972. Two years later the organization started a cooperative bank based in the city of Ahmedabad with $1,300 contributed by 5,000 members . (Chen 2003) Where not specifically cited, the information for this case study is from the bank's website, www.sewabank.org.

Business Model

Shortly after its creation, the bank started a "doorstop banking" program by driving vans to meet with members, the vast majority of whom are women. In 2000, a field staff of "handholders" was mobilized to offer face-to-face service wherever it is most convenient for individual bank customers. This staff is assigned a fixed geographic area and thus develops lasting friendships with clients and a detailed understanding of their business needs. The bank stresses the importance of working around the schedule of people employed in the informal sector and around the small sums of money frequently deposited and withdrawn. SEWA Bank minimizes the amount of writing and reading necessary to complete loan applications and other common forms.
image source: sewabank

Financial Services

The bank tailors its services to address the specific problems encountered by workers and business owners in the informal sector in India. Clients can receive loans specifically for upgrading infrastructure at their place of business. Bank coordinated life insurance, maternity benefits, and asset insurance help provide a support system similar to that of the formal sector. Clients also receive business counseling, minimizing the negative effects of poor education and lack of access to information. Chen (2003) found that customers use these services differently, depending largely on their specific role in the informal economy:

Street Vendors
Street vendors have used standard loans to move up from selling out of a basket, to a cart, to a storefront. SEWA successfully lobbied for informal vendors to have a legal place to sell in the city.
Home Workers
Home workers in the textile industry have used housing loans to upgrade their places of business. The addition of porches and new rooms permit these women to work without interruption from family members. A division of SEWA that specializes in housing fights against evictions in cases where tenure is not secure. It also has brought basic infrastructure to many slums by developing a framework for cost sharing between residents, the municipality, and external private capital.
Rural Workers
SEWA linked rural farmers with wholesale buyers in the city, providing a dependable market for their products. The organization itself operates a wholesale shop to further assist small-scale agricultural enterprises. To enable these workers to tap related sources of income, SEWA provides training in raising cattle and maintaining a nursery.

As can be seen, SEWA and SEWA Bank work closely with clients to find solutions to problems encountered in the informal economy. These innovations serve as the basis for local economic development and community building.

 

Conclusions

This essay has provided an overview of the major issues facing business owners and workers in the informal economy in the developing world. The short case study of SEWA Bank was selected because of how the organization has fine tuned its services to sector specific needs. Many of these solutions appear adaptable to other countries as well.

 

Bibliography and Further Reading

Organizations

The Self Employed Women's Association (SEWA)

Women in Informal Employment: Globalizing and Organizing (WIEGO)

Online Publications

Bhatt, Elaben, “Lessons Learnt” (sic), SEWA Bank, sewabank.org : accessed 11/15/2005

Becker, Kristina, “The Informal Economy”, Swedish International Development Cooperation Agency (SIDA), Department of Infrastructure and Economic Cooperation, March 2004

Carr, Marilyn, and Chen, Martha, “Globalization and the Informal Economy: How Global Trade and Investment Impact on the Working Poor”, Women in Informal Employment Globalizing & Organizing (WIEGO), May 2001

Chen, Martha, “Rethinking the Informal Economy: Linkages with the Formal Economy and the Formal Regulatory Environment”, United Nations University , EGDI, WIDER, September 2004

Chen, Marty, et al, “The Investment Climate for Female Informal Businesses: A Case Study from Urban and Rural India”, September 2003

Chen, Martha, et al, “Supporting Workers in the Informal Economy: A policy Framework”, International Labor Office (ILO), February 2002

Lund, Frances and Skinner, Caroline, “Local Government Innovations for the Informal Economy Creating a Positive Investment Climate”, World Bank Institute, Development Outreach, March 2005 issue.

World Bank Group, “Local Economic Development (LED) The Informal Economy and Local Economic Development" : accessed 11/15/2005

Hardcopy Publications

International Labor Office (ILO), Decent Work and the Informal Economy , International Labour Conference, 90 th Session, 2002