ISET Economist Blog

Why Care About Informal Employment?
Friday, 20 June, 2014

Before answering this question, let us define what economists usually mean by” informal employment”. There is some confusion with this term, and sometimes it is improperly used as a synonym for tax evasion or illegality. ILO defines informal employment as: employment “consisting of units engaged in the production of goods or services with the primary objective of generating employment and incomes to the persons concerned. These units typically operate at a low level of organisation, with little or no division between labor and capital as factors of production and on a small scale.” In such jobs, labor relations are based mostly on casual employment, kinship, or personal and social relations rather than contractual arrangements with formal guarantees. Employment benefits, such as social protection, health insurance, paid leaves, and others are absent while minimal documentation is kept about operations of such units (for example, no payslips are issued or kept).

Traditionally, informal employment has been seen as a predominantly involuntary phenomenon, with workers wishing to participate to the formal labor market but unable to do so because of the lack of opportunities.

For sure, after the collapse of the Soviet Union, when employment fell rapidly in formal sectors, people managed to survive by engaging in a multitude of ‘informal’ (undeclared) activities, such as: street trading, subsistence agriculture, and unofficial taxi services. In Georgia, the largest increase in informal employment took place in rural areas, where the population could rely on more abundant natural resources and agricultural activity. In the 1990s in Georgia, when the structural changes in the economy forced large groups of people to migrate back to rural areas and engage in agriculture in order to satisfy their subsistence needs. Since then, more than half of people employed in agriculture are mainly employed in the informal sector.

Informal economy in rural sector functions as an alternative distribution network where those without access to or possession of cash to buy goods and services are able to access at least some of what they need for both production and consumption (Ratner, 2000). Another advantage of the informal economy in rural areas, according to Slack (2005) is the ability to remain self-sufficient through engaging in a wide range of alternative economic activities. The informal economy in rural areas provides also the opportunity to combine formal employment with informal or unrecorded work, barter, or other forms of nonmonetary exchange and self-provisioning (Ibid, 2005).

Informal employment, of course, exists also in the cities. Every day, thousands of individuals engage in activities as diverse as taxi driving, basic construction/repair works, street selling, and so on. Also, in this case, the informally employed have to rely on their capacity to combine several forms of employment to earn enough to survive.

This picture of informal employment, however, is not exhaustive. A number of economic studies tell us that the picture is much more complex. Informal employment is, sometimes, a choice not determined from need but from the desire to maximize one’s well-being (for example by avoiding exceeding a certain level of personal – declared – income). According to several authors, like Rosenzweig (1988) and Maloney (1999 and 2004), many workers choose informal employment voluntarily and, given their characteristics, have higher utility in an informal job than in a formal one. This school of thought has even raised doubts about the preferability of formal sector jobs with respect to informal ones.

Indeed, in most cases, both types of informal employment (voluntary and involuntary) are likely to coexist in the economy. This is, for example, the conclusion reached by Hartmut Lehmann and Norberto Pignatti (2007) about the Ukrainian labor market. The authors did find some evidence of labor market segmentation among the salaried employees who were involuntarily informal and who were informally employed while queuing for formal salaried jobs. However, segmentation was not the whole story. Both among the salaried employees and – even more – among the self-employed, informality appeared to be a choice, leading to higher volatility of earnings but also to higher expected earnings. The results for Ukraine are consistent with the Georgian experience. A study done by Bernabè and Stampini (2009) about labor mobility during the transition in Georgia – in the years 1998-1999 – showed that there was labor market segmentation. Formal employment was preferred to informal employment. Unemployment was largely a queuing device for individuals with higher education waiting for formal jobs. Some self-employed were focused on subsistence activities, consistently with a segmented labor market, while others were engaged in high risk and potentially high return activities. Finally, Bernabè and Stampini (2009) found that informal employment served as a buffer in times of recession.

This brings us back to the initial question of this article. Why care about informal employment? Traditionally, public authorities have been trying to fight informal employment mostly because informal activities in most cases pass “under the radar” and can cause a series of negative consequences. Competition is distorted, as enterprises employing informal workers enjoy an unfair comparative advantage (they can pay less for the same services for which their competitors have to pay – in addition to wages – taxes and social benefits). At the same time, the public budget suffers both from lower tax revenues and from higher social benefit payments, as the informally employed appear to be without a source of income and are therefore more likely to be considered eligible for financial support.

Despite these very good reasons to fight informality, however, the very fact that being informally employed in many cases might be not a choice but a necessity should urge a cautious and pondered approach. After all, if the informal sector provides a sort of “alternative (or complementary) safety-net”, favoring in some instances even the accumulation of human and financial capital, adopting a purely repressive approach could actually backfire, affecting negatively the development perspectives of the country and increasing the pressure faced by public authorities and the stress on public finances.

The Georgian government is currently engaged in a ponderous effort to improve its capacity to design and pursue sustainable development policies. A fundamental step towards sustainable development is ensuring that growth is inclusive. This requires a clear and deep understanding of the mechanisms at work in labor markets, of the reasons why the formal sector has so far failed to absorb a large part of the labor force, and of what can be done to reverse this trend. A better understanding of the nature and of the reasons for the success of the informal sector constitutes definitely a step in the right direction. As we argued in our previous blog post, informality in Georgia is not only an economic phenomenon; it is a cultural one, and any attempt to govern it should be done keeping this in mind. The strength of the personal and family networks, for example, could constitute a powerful factor helping the diffusion of information, the basis for the aggregation of common interests, and a fundamental tool to help the more disadvantaged access better opportunities. The same ties could also constitute a way to increase the voice of the weakest components of society. Working along these lines rather than independently of (or against) them could prove way more effective in achieving the desired results.

Unfortunately, so far very limited research has been done in this direction, for transition countries in general and for Georgia in particular, mainly because of lack of appropriate – and updated – data. ISET work, in the context of the project Understanding the Puzzle of Informal Employment in Georgia, supported by VolkswagenStiftung, is exactly going in this direction. We are taking advantage of a new, nationally representative, Georgian labor survey dataset collected in 2013 to look for insights into the functioning of the Georgian informal labor market (and of informal labor markets in general). We hope our contribution will help shed light on informal employment in Georgia and on the way it has been developing during almost 25 years of transition, a crucial starting point – in our opinion – to make the development of the Georgian economy truly inclusive and sustainable.

The views and analysis in this article belong solely to the author(s) and do not necessarily reflect the views of the international School of Economics at TSU (ISET) or ISET Policty Institute.