The Informal Economy: What It Is and Why It Is Important? The informal economy r

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The Informal Economy: What It Is and Why It Is Important?

The informal economy refers to commercial activities that occur at least partly outside a governing body’s observation, taxation, and regulation. In slightly differ- ent words, sociologists Manuel Castells and Alejandro Portes suggest that the “informal economy is character- ized by one central feature: it is unregulated by the insti- tutions of society in a legal and social environment in which similar activities are regulated.” Firms located in the informal economy are typically thought of as busi- nesses that are unregistered but that are producing and selling legal products (that is, they sell many of the same products you might buy in legal businesses but perhaps cheaper because they do not pay government fees and taxes). In contrast to the informal economy, the formal economy is comprised of commercial activities that a governing body taxes and monitors for society’s bene- fit and whose outputs are included in a country’s gross domestic product. For some, working in the informal economy is a choice, such as is the case when individuals decide to supplement the income they are earning through employment in the formal economy with a second job in the informal economy. However, for most people work- ing in the informal economy is a necessity rather than a choice—a reality that contributes to the informal econo- my’s size and significance. Although generalizing about the quality of informal employment is difficult, evidence suggests that it typically means poor employment condi- tions and greater poverty for workers. Estimates of the informal economy’s size across coun- tries and regions vary. In developing countries, the infor- mal economy accounts for as much as three-quarters of all nonagricultural employment, and perhaps as much as 90 percent in some countries in South Asia and sub- Saharan Africa. But the informal economy is also prom- inent in developed countries such as Finland, Germany, and France (where the informal economy is estimated to account for 18.3 percent, 16.3 percent, and 15.3 percent, respectively, of these nations’ total economic activity). In the United States, recent estimates are that the infor- mal economy is now generating as much as $2 trillion in economic activity on an annual basis. This is double the size of the U.S. informal economy in 2009. In terms of the number of people working in an informal economy, it is suggested that “India’s informal economy … (includes) hundreds of millions of shopkeepers, farmers, construc- tion workers, taxi drivers, street vendors, rag pickers, tai- lors, repairmen, middlemen, black marketers, and more.” There are various causes of the informal economy’s growth, including an inability of a nation’s economic environment to create a significant number of jobs rel- ative to available workers. This has been a particularly acute problem during the recent global recession. In the words of a person living in Spain: “Without the under- ground (informal) economy, we would be in a situation of probably violent social unrest.” Governments’ inabil- ity to facilitate growth efforts in their nation’s economic environment is another issue. In this regard, another Spanish citizen suggests that “what the government should focus on is reforming the formal economy to make it more efficient and competitive.” In a general sense, the informal economy yields threats and opportunities for formal economy firms. One threat is that informal businesses may have a cost advantage when competing against formal economy firms because they do not pay taxes or incur the costs of regulations. But the informal economy surfaces oppor- tunities as well. For example, formal-economy firms can try to understand the needs of customers that infor- mal-economy firms are satisfying and then find ways to better meet their needs. Another valuable opportunity is to attract some of the informal economy’s talented human capital to accept positions of employment in formal economy firms.

1. What are the implications of the informal economy for firms that operate only in the formal economy?

2. When firms consider analyzing their competition, should they include firms in the informal economy? Please explain why or why not.

3. What opportunities does the informal economy present to firms operating in the formal economy?

4. What threats does the informal economy present to firms operating in the formal economy?

5. How do firms operating in the formal economy identify and analyze the parts of the informal economy relevant to their strategies?

Explanation / Answer

1) the implications of the informal economy for firms operating only in the formal economy are of higher costs incurred due to payment of taxes and cost of compliance with statutory regulations leading to higher input cost for similar products or services being offered within the informal economy, greatly impacting their ability to compete on better pricing. The informal economy is also able to procure goods through illegal channels at much lower costs. The services provided may also be cheaper as the staff is employed for low packages not complying with statutory requirements. This create serious threat in the form of competition which is difficult to handle in a legal manner, or on the basis of Management strategies as the informal economy has an undue advantage.

2) Firms considering an analysis of their competition need to include firms in the informal economy as many of their decisions, including pricing of products and services may be based upon actions of such firms. These firms can seriously impact the market share of formal firms, even though actions a formal firm can take against informal firms in the same segment, to compete or control their activities are greatly restricted, it is essential to keep track of their activities to be able to understand the markets and make rational decisions. Therefore it is essential to account for them within competition.

3) firms operating in the formal economy can benefit from ideas generated through the informal economy buy market analysis and better understand consumer needs and exploit this requirement by providing better products or services with greater value proposition for the consumer and matching requirements or also see an existing identified gap within such markets. An analysis of the activities of the informal economy can provide valuable data on markets and consumer trends.

4) the major threat informal economy presents to firms operating in the formal economy is of unfair competition in pricing possible due to low input cost available to businesses operating within the informal economy due to not complying with legislatures, therefore not incurring any cost of regulations or paying taxes.

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