Policies and measures to formalize the informal economy

1
Policies and measures to formalize the informal
economy

• Presentation for the ILO-ITC seminar on
  Employment and Informal Economy
• March, 2009
• Prof. Krastyo Petkov-Bulgaria
• Kr.petkov_at_wnwe.eu

2
CLASIFFICATION AND FACTORS

• 1. Definitions different criteria and concepts
• /black, shadow, underground, hidden economy/
• 2. Three sectors of the hidden economy
• Informal /legal/
• Grey /semi legal /
• Black / I legal /
• 3. Segmentation of the labour market in the IE
• 4.Factors for the IE growth
• Global
• Intraregional
• National
• Neo liberal reforms

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First part

• INTRODUCTION

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Evolution of meanings

• Important massage
• Informal Economy /IE/ is not a temporary,
  transitional phenomenon , as it used to be
  described in the theory and practice

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Past significance

• Initial considerations of Informal Economy /IE/
  were related to imaging it, as just an adjunct to
  the official economy.
• Gradually IE marked a certain growth. It
  involved c branches and regions, thus, engaging
  numerous in figures and sustainable in time,
  labor and business groups.
• It transformed from a safe-way for unemployed
  and low-income groups, into a factor, adding to
  the overall economic growth.

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Present importance

• Today, informal work parallels labor, applied in
  the formal economy and thus, informal employment
  turns into a significant source of primary and/or
  secondary (marginal) incomes for individuals.
  This process happens, primarily in the developing
  countries.
• National economies, especially in times of
  crisis, evolve to new economic equilibria and
  dynamics, rooted at two inter-dependent economic
  sectors the formal and informal one.

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Second part

• STATISTICS

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IE size in the transition countries

• The share of informal sector in Central Europe is
  estimated at 15-20 of the total number of
  employed. Percentage levels of this share in the
  Baltic Region, Bulgaria, Romania, and Croatia
  vary in between 20 and 35. However, in two
  territorially distant regions, flourishing of
  informal economic activity is observed. For
  instance, in the states of ex-Yugoslavia, this
  percentage range is 40-50, and in the Asian
  teritiries of the ex-USSR, this is a range of 50
  to 80 of all employed.

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IE in 21 OECD countries
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Factors for the IE growth

• -Global /including financial and economic
  crisis/
• - Intraregional /common past, present links/
• - National /traditions, regulations/
• -Neo liberal reforms deregulation paradigm/

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Third part

• DEFINITIONS

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General definitions

• Mixed criteria-many definitions
• IE is a market-based production of goods and
  services, whether legal or illegal, that escapes
  detection in the official estimates of GDP.
• Or to put it in another way, one of the broadest
  definitions of IE includes
• those economic activities and the income
  derived from them that circumvent or otherwise
  avoid government regulation, taxation or
  observation.

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Concrete definition

• I
• The Informal Economy includes all market-based
  legal production of goods and services that are
  deliberately concealed from governments for the
  following reasons
• 1. to avoid payment of income, value added or
  other taxes,
• 2. to avoid payment of social security
  contributions,
• 3. to avoid having to meet certain legal labour
  market standards, such as minimum wages,
• maximum working hours, safety standards, etc.,
• 4. to avoid complying with certain
  administrative procedures, such as completing
  statistical questionnaires or other
  administrative forms.
• -------------
• Source
• The Shadow Economy in Germany A Blessing or a
• Curse for the Official Economy?
• Friedrich Schneider
• ECONOMIC ANALYSIS POLICY, VOL. 38 NO. 1, MARCH
  2008

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PERC project typology

• In general, there are two types of underground
  economic activities illicit employment and the
  production of goods and services consumed within
  the household. PERC methodology focuses on the
  former type and excludes illegal activities such
  as drug production, crime and human trafficking.
• The latter type includes the production of goods
  and services, consumed within the household or
  childcare and is not part of this analysis
  either.
• Thus, PERC analysis only focuses on economic
  activities that would normally be included in
  national accounts but which due to tax or
  regulatory burden remain underground.

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Forth part

• WHY I E GROWS?

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Main Causes of IE growth-1

• 1. Tax and Social Security Contribution Burdens
• Since taxes affect labour-leisure choices, and
  also stimulate labour supply in the shadow
  economy, the distortion of the overall tax burden
  is a major concern for economists. The bigger the
  difference between the total cost of labour in
  the official economy and the after-tax earnings
  (from work), the greater is the incentive to
  avoid this difference and to work in the shadow
  economy
• 2. Intensity of Regulations
• Increased intensity of regulations is another
  important factor which reduces the freedom (of
  choice) for individuals engaged in the official
  economy / labour market regulations, trade
  barriers, and labour restrictions for
  foreigners./

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Main causes of IE growth-2

• 3. Public Sector Services
• An increase of the shadow economy can lead to
  reduced state revenues which in turn reduce the
  quality and quantity of publicly provided goods
  and services.
• Ultimately, this can lead to an increase in the
  tax rates for firms and individuals in the
  official sector, quite often combined with a
  deterioration in the quality of the public goods
  (such as the public infrastructure) and of the
  administration, with the consequence of even
  stronger incentives to participate in the shadow
  economy.
• Important note Countries with more general
  regulation of their economies tend to have a
  higher share of the unofficial economy in total
  GDP, is found in their empirical analysis.

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Some Intermediate Conclusions

• 1.Smaller shadow economies appear in countries
  with higher tax revenues if achieved by lower tax
  rates, fewer laws and regulations and less
  bribery facing enterprises. Countries with a
  better rule of law, which is financed by tax
  revenues, also have smaller shadow economies.
• 2. Transition countries have higher levels of
  regulation leading to a significantly higher
  incidence of bribery, higher effective taxes on
  official activities and a large discretionary
  framework of regulations and consequently a
  higher shadow economy.

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Intermediate Conclusions-2

• The overall conclusion is that wealthier
  countries of the OECD, as well as some in Eastern
  Europe, find themselves in the good equilibrium
  of relatively low tax and regulatory burden,
  sizeable revenue mobilization, good rule of law
  and corruption control, and a relatively small
  unofficial economy.
• By contrast, a number of countries in Latin
  America and the former Soviet Union exhibit
  characteristics consistent with a bad
  equilibrium tax and regulatory discretion and
  burden on the firm are high, the rule of law is
  weak, and there is a high incidence of bribery
  and a relatively high share of activities in the
  unofficial economy.

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Fifth part

• IE in the CEE/SEE regions

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Informal Economy Stages
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What is behind this trajectory?/Some arguments
from PERC analysis/

• Informal employment appeared simultaneously with
  the political changes in the 80s, which period of
  time is known as the perestroika. During the
  totalitarian period of time, each informal
  activity (excluding home-centered activities),
  was considered, as a rule, to be illegal and was
  penalized by official authorities. Another
  exception to this generalization are the small
  segments of agricultural activities in the field
  of land cultivation, mutual service exchanges
  among house-holds, where there is relatively no
  direct state intervention in labor market
  relations of private/family nature (Poland,
  Hungary, Bulgaria, and others).
• Since 1989 a period of forced and chaotic
  informalization came, due to the neoliberal
  economic reforms, imposed in the 90s within the
  whole vast region of the Central and Eastern
  European Countries. The boom of unregulated
  employment is a result of the specific and
  compressed in time processes of privatization and
  economic restructuring of the big state-owned and
  state-managed companies in a large scale. These
  processes were coupled with mass liberalization
  of labor force without applying adequate measures
  for support of the emerging labor markets. Some
  of these measures, which were never applied as
  economic tools are requalification of
  individuals, labor market brokerage, labor market
  funneling of the labor force, stimulation of
  self-employment and other tools.
• The next, third wave, which occurred during the
  first decade of the 21st century, is a period of
  time, when most of the national economies of the
  Eastern and South-East Europe were modified into
  a test-field to apply the principles and policies
  of the Washington Consensus and its relevant
  tools for imposing shock therapies.
•  

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How it happened in the CEE / PERC Project/

• Countries from the first round/circle, included
  in the ITUC/PERC project /SEEformer Yugoslavia/
  and in the second circle /NIS-ex-USSR/ conducted
  two interlinked changes
• -Transformation One it was typical for the
  ex-Soviet area and transition from state-planned
  to market-driven economy was completed
• -Transformation Two represents transition
  from one-party governance to political and trade
  unionist pluralism
• National Mapping Reports show that both
  transformations were conducted in parallel, and
  there were times, where they were discontinued
  every now and then by economic cycle crises or
  corrections in the models for reforms /Ukraine,
  Serbia, Georgia/ by political crisis and more
  specifically, by local destabilization /including
  ethnic-based conflicts/ and by external
  inter-state tensions and collision /typical to
  all countries, included in the project/.

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Chronology of the events

• Emerging of IE is related to increasing
  insecurity and freedoms of movement of people and
  work force.. Transition from regulated
  employment, mainly from occupations in
  state-owned companies to occupations in the
  emerging informal private businesses is a result
  of the spontaneously derived strategy for
  survival in crisis situations.
• The other impulse for spontaneous informalization
  is due to the prevailed economic chaos, which
  occurred after the elimination of the
  party-state, top-to-bottom control mechanisms
  /that is, elimination of the command-administrativ
  e system/. The embargo regiments, applied in the
  region of the Western Balkans are the other
  generator of unregulated trade, illegal migration
  and proliferation of trans-border informal
  economic networks.
• In terms of chronological order, ethnic and
  religious conflicts (including armed conflicts in
  the Western Balkans and the Caucasus) were first,
  then transition times came (time of economic
  reforms, imposed by the IFIs and applied by the
  respective national governments, who followed the
  neoliberal doctrine for building free and
  perfect markets).
• The second period lasted until the economic
  crisis of 2007-2010. However, the EMEs do have
  neither automatic stabilizers, nor buffers, nor
  networks to protect the affected by the crisis
  professional groups and businesses.

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The Informal Economy Boom

• All countries without exceptions, in both
  sub-regions, are turning from industrial-agricultu
  ral or mainly agricultural states into economic
  areas with domination of services, retailing and
  dispersed micro-production factories, based on
  sub-contractual relations.
• This is demonstrated by the branch distribution
  of informal activities in all nine countries,
  subject to the ITUC/PERC project

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Positive Effects

• - finding jobs (which diminishes unemployment
  rates) the process of accruing additional
  incomes for individuals (which diminished
  poverty
• - evolving the way services are provided to the
  market (which was limited by the party-state
  system )
• - producing demanded goods mainly in the
  processing industry, information industries
  (internet, and mobile technologies, which allow
  individuals to work from their homes, or from a
  distance the e-economy, in general)
• - greater use of labor potential of households
  and so on

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Negative effects

• To the negative effects all national analysts
  relate
• - at first place, direct and indirect practices
  to circumvent labor and social standards and
  acts.
• -diminishing tax incomes and social security
  proceedings into national treasury turns into
  financial burden for the state and social burden
  for the individuals.
• More examples of negative effects may be given
  here, such as non-loyal business competition
  /social dumping/, woman and child labor
  exploitation, criminalization of businesses
  /where shadow and black segments are organically
  inter-mingled/, administrative corruption, and
  others.

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Sixed part

• FORMALISATION
• OR
• IDENTIFICATION?

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Evolution of concepts and polices

• Transformation by economic sectors takes
  comparatively long time /half a century, at
  least/ during this period of time economic
  theories and political views evolve, in terms of
  their relation to informal activities.
• Although official data for developing countries
  show that even today the share of unregulated
  labor is comparatively low , the phenomenon
  informal economy becomes a focal point for the
  strategic analysts and decision-makers.
• Processes of the last decade changed
  significantly EUs official position and attitude
  towards the process of informalization of the
  economy. The very accent of the EU policy altered
  the banning norms /restrictive / into curative
  regulations and gradual legalization of some
  segments of the informal employment.
•  

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Three Competing Views of the Informal Economy and
Economic Development

• By definition, informal businesses are hidden
  from the eyes of the state and so most of what we
  have relies on estimations and very micro-level
  studies.An cross-country report that appeared
  in the Brookings Papers on August 2008 aims to
  improve the understanding of the relationship
  between economic development and the informal
  economy.

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The romantic view

• According to this view informal firms are
  actually or potentially extremely productive, but
  held back by government taxes and regulations as
  well as by the lack of safe property rights and
  access to finance.
• If such barriers were lowered, informal
  businesses would register and take advantage of
  the benefits of their formal status. Thus, this
  view assumes that unofficial firms are
  fundamentally similar to official ones.

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The parasite view

• The parasite view states that informal firms
  need to stay small to avoid detection.
• The decision to remain in the informal economy
  is a rational one, because the cost advantage of
  avoiding taxes and regulations allows unofficial
  firms to undercut official firms in prices.
• Informal firms are thus hurting growth because
  their small scale makes them unproductive and
  because they take away market share from more
  productive, formal competitors. Government policy
  should aim to eradicate informal firms by
  reducing tax evasion and increasing government
  regulation enforcement.

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The dual view

• Informal and formal firms are operating in
  different markets and have different customers so
  they do not compete against each other.
• Since informal firms provide livelihoods to
  millions of people, government policies should
  not raise the costs of doing business for them.
• Instead, the role of government policies should
  be to promote the creation of official firms and
  let the informal ones die as the economy
  develops.

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Additional arguments for the new identity

• Since there is such a productivity gap between
  formal and informal firms and considering that
  there is no evidence that informal firms become
  formal as they grow, stimulation of formal firms
  is necessary for economic growth.
• The evidence points out that a best move would
  be to support the creation of formal firms run by
  educated managers and utilizing modern practices
  to stimulate economic development.

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IE-Crisis

• Figures published by the Organization for
  Economic Cooperation and Development (OECD) show
  that the world has more people working informally
  than formally.
• Campaigners emphasize that informal workers are
  not necessarily illegal workers. The OECD says
  that a record 1.8 billion workers are employed in
  underground activities, compared with 1.2 billion
  in the formal sector.
• During a recession, dismissed workers frequently
  have to move to the first available job, even if
  it is of a lower quality than the one they have
  lost. It says that this will have a profoundly
  negative effect on the United Nations Millennium
  Development Goal to halve the number of people
  who live on less than 1 (69p) a day.

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IE-Migration

• Between 4 million and 8 million people reside
  illegally in Europe. Ilegal migration is a top
  priority in European politics for the past few
  years.
• Illegal migrants come mainly to the Mediterranean
  countries from Africa, Eastern Europe, and the
  Middle East. Most of them also choose to stay
  permanently. Low fertility rates and aging
  populations coupled with a higher level of
  education have led to labor shortages in
  low-paying sectors.
• Italian sociologist Emilio Reyneri's the IE in
  Southern Europe has a pull-effect on migration.
  The IE has deep social and historical roots and
  has not been caused by immigration. The
  opportunities for informal work, strengthened by
  the fact that there are labor shortages in
  sectors where natives no longer want to work, has
  made these countries attractive for migrants.

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The end

• Thanks for the attention!
• Any questions?

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Re-conceptualization of IE

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