The informal economy is the reality of most of the world’s working population. According to the International Labor Organization (ILO), 61 percent of workers are informal in the world, and 90 percent of them are in developing countries. This phenomenon is greater in developing countries such as Latin America and the Caribbean, which has an informality rate of 53.1 percent, indicating that approximately 130 million Latin American people work in this sector. The situation is more profound because many, if not 100 percent, have no contract or social benefits, and most have to turn to the market to make ends meet for the day. These indicators reflect that many developing countries have had to live with the informal economy, which has become the norm among them. However, this norm has steadily increased due to the COVID-19 pandemic. In this context, how can employment in this sector be boosted?
Informal Sector in Latin America
The International Monetary Fund (IMF) report developed by Medina and Schneider (2018), entitled “Shadow economies around the world: what did we learn in the last 20 years?”, shows interesting evidence. This study compiles information on the phenomenon of underemployment from 1991 to 2015 and takes into account 158 countries. The results show that the countries with the highest levels of informality are Zimbabwe, with 60.6, Bolivia, with 62.3, and Georgia, with 64.9. On the other hand, the smallest informal economies are Austria with 8.9, the United States with 8.3 and Switzerland with 7.2. The same study shows that Latin America has the highest level of informality on average.
Latin America has had to live with the complex and dynamic informal economy for many years. According to some studies, informality is associated with lower growth. Other studies also suggest an inverted-U relationship between informality and growth (Loayza, 1999; Johnson, Kaufmann and Shleifer, 1998; Elgin and Birinci, 2016). In addition, across the region, there is also a significant variation; Bolivia, Nicaragua, Guatemala, and Honduras present the highest level of informality; and the lowest levels are found in Uruguay, Costa Rica, and Chile. In terms of gender, women show more informal employment than men, 54.3 percent and 52.3 percent respectively. Taking into account the geographical aspect, rural areas show 68.5 percent informality and urban areas 47 percent. (ILO, 2018)
But what are the drivers of this type of economy? The drivers of informality are diverse and vary across countries but among them are monetary, regulatory, institutional, behavioral and structural factors. Monetary drivers include avoiding paying taxes and all social security contributions. Regulatory factors consist of avoiding governmental bureaucracy or the burden of regulatory framework. Institutional drivers include corruption, low quality of political institutions and weak rule of law (Medina and Schneider, 2017). Behavioral factors include decisions to become informal/formal, which are based on workers’, firms’ and households’ valuation of the net benefits of formality, awareness and trust. Structural drivers involve the pressure exerted by surplus low-skilled labour which continues to be a major driver of informal employment in many developing countries, according to ILO/OECD.
Death by Covid-19 or Hunger?
COVID-19 and the quarantine measures further worsened the situation of the informal sector because the confinement measures caused the loss of livelihoods and led these workers to face the great dilemma of dying of hunger or the virus (ILO, 2020). Many of these workers in the informal economy are poor and most lack labor, social and health protection. The informal sector has to work “no matter what” to have food for the day. Public policies are urgently needed to protect these workers and recognize their value as providers of essential services, which are a fundamental pillar in various sectors of the economy, such as food security, industry and services. (Gerdin and Kolev, 2020).
The informal economy will require comprehensive and long-term support. Even more so with all the uncertainty that comes with this virus, which is likely to worsen in the coming months and perhaps years. Governments must act now to enable their most vulnerable citizens to cope with the crisis. Most are essential workers who today are responsible for many economic activities. Despite the enormous value of this work in sustaining our economies and societies, informal workers are too often excluded or marginalized in economic and social policy. This needs to change, and action needs to be taken very quickly, as the cost of inaction is – and will be – enormous. (Alfers et al., 2020; Gerdin and Kolev, 2020).
Microcredits can be a solution?
The growing visibility of the informal economy is one of the most striking phenomena characterizing the economy of the developing world. Closely related to this phenomenon is the emergence of a number of microfinance institutions (MFIs) that respond to the financial needs of informal workers who are unable to access the formal financial market due to the many constraints imposed by them. Microfinance is an increasingly popular financial strategy, providing credit to those excluded from the formal sector to promote and support small business investment. MFIs offer the missing link for low-income people with entrepreneurial expectations.
Professor Muhammad Yunus, a pioneer of the microfinance industry in the late 1970s, established the first institution, the Grameen Bank, which used the microcredit to develop informal businesses in Bangladesh. The UN Secretary-General Kofi Annan also stated that, “providing microloans to help poor people launch small businesses recognizes that they are the solution, not the problem. It is a way to grow productive enterprises, and so allow communities to prosper.” (United Nations – International Year of Microcredit, 2005)
The growth of microcredit in Latin America has become a key initiative for the region’s development. It should be noted that microcredit in Latin America differs from the Asian approach, which is more rural and focused on fighting poverty. Microcredit in Latin America is more focused on small businesses and microenterprises in urban areas. It targets poor people with established businesses that need capital to grow even from scratch. An example of pioneering and successful microfinance is Bolivia, which marked a milestone with the opening of the “Banco Sol”. The microfinance industry in this country has evolved into a highly profitable and commercialized industry. Microfinance is an immensely popular strategy in Bolivia because it boosts small businesses commonly found in the informal sector.
In this context, developing country governments could counteract the pandemic crisis in the informal sector through aggressive unconventional measures such as microcredit. These can be provided at low interest rates and with extended terms to cope with the crisis. Governments have a crucial role to play in carrying out these measures, all with the aim of safeguarding the most vulnerable population.
*Note: Research project in process.
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– Michaël Wegmüller –
– Mariela Chacaltana Bonifaz –
– Wilma Ticona Huanca –