Economic informality: a threat or a strength?

As with almost everything in economics, the answer is “it depends.” And it is that, in times of economic crisis such as the current one, economic informality could attenuate the increase in unemployment.

When one stops to think about the great evils that threaten our economy, one of the first issues that always comes to mind is usually that of economic informality. The underground economy, as they call it in Spain, is one of the elementary problems that society faces all over the planet, so the International Labor Organization (ILO), as well as a number of other organizations, are, of course, continuously, proposing policies to combat it.

And, when we talk about economic informality or underground economy, we are not referring to a specific economy, but we are talking about a general problem, which is present in many economies throughout the planet. Well, safeguarding peaks of economic informality in underdeveloped and emerging economies, we are talking about the fact that the Organization for Economic Cooperation and Development (OECD), integrating a large cast of developed economies among its members, presents an informal economy equivalent to 15% of the product gross interior (GDP).

In Europe, this figure rises to 22%, placing the list of developed economies above the average set by the OECD. However, these data, despite being relevant, are still one of the lowest data known. If we look at the economic informality that Latin America presents, for example, we must highlight that we are talking about about 140 million people throughout the continent who, at the moment, are employed in the informal economy, so their informality in the field labor is above 50% of workers. But it is that, if we contrast this data with the GDP, we are talking about an informality that slightly exceeds 40% of the GDP; reaching levels of 60% in countries like Bolivia, or 70% in countries like Guatemala.

Economic Informality Economies

However, number up, number down, the informal economy is a phenomenon that is very difficult to combat. Although we talk about the fact that economic informality in Mexico, for example, is 22.5% of GDP, we must know that this data is still an estimate. Well, as its name indicates, we are talking about economic informality, that is, money that could be found outside the national accounts, so its presence is only an estimate, since it is impossible to count a series of data from the that is not available. For this reason, it presents great difficulties when combating it, since the exact level of it is unknown.

At the same time, we are talking about an issue that, in economic theory, is not fully defined. In other words, it is unknown how certain policies may impact on different countries, so the risk that these policies may generate negative externalities leads them to continue betting on the policies applied to date; and not by those that, in the same way that they could combat the informal economy, could cause an outflow of capital, as well as a flight of companies, from those countries that try to reverse the situation.

In the same way, finally, political will, in scenarios in which corruption is a structural problem of the territory, becomes the main problem to combat; even surpassing the economic informality itself. Well, in countries where economic informality has become a business for the government itself, ending it requires complementary actions that sometimes have no impact on the population. Well, as I say, we are talking about economies that have more informal economy than, in this case, economy in general.

But is the black economy so bad?

The underground economy, as we have commented, is one of the main burdens that an economy can present for its proper development. Well, as such, we are talking about a phenomenon that has serious consequences on the economy of a territory. Job insecurity, scarcity of public resources to meet certain obligations, lack of competitiveness, low added value and institutional weakness are some of the symptoms of those economies with the highest degree of informality.

And, in the informal economy, the protection that the State can offer a worker is minimal, since it does not even count for the State itself as a worker. In the same way, by not computing, labor laws are violated, resulting in greater job insecurity. Likewise, this means that, by not paying taxes for their work, neither the employee nor the employer has to answer for their work with the payment of taxes, which limits the capacity of the State and reduces its institutional strength. While, finally, the low-skilled employment that is usually employed in the informal economy means that the work, in addition to presenting this low added value, also does not promote the competitiveness of a business fabric that focuses its attention on deceiving the State and not on compete in international markets.

However, in the same way that negative connotations of the underground economy are shown, COVID, as well as other scenarios that are observed in the study of this phenomenon, leave us positive conclusions on some aspects that, having been practiced by the informal economy , if they have been found to be successful in their application. Well, sometimes we tend to say that virtue is to keep the best of each thing, to apply it and discard what does not work. However, when we talk about the informal economy, we forget some aspects of it that have a good result, but that, when encompassing everything in the same phenomenon, go unnoticed.

The same is the case with the flexibility in the labor market offered by those economies with a higher degree of economic informality. A flexibility that, in the same way that it reduces and precarious the employee’s profession, endows him with the strength to keep his job over time. A robustness that, in times of COVID, as highlighted by the little protection offered by those countries with a higher degree of informality, is surprising due to the scarce need of these countries by destroying less employment than that registered in those economies that, being more transparent They were also less flexible.

The black economy and flexibility in the labor market

Based on the studies offered by the International Monetary Fund (IMF), if we analyze the link between variations in GDP and unemployment, it would be observed that the informal market plays an important role during the economic cycle. And this is what the international body has done, showing that unemployment rates in economies with a higher degree of economic informality, such as emerging economies, are less sensitive to fluctuations in GDP than in advanced economies, such as Europe, for example.

Well, it is striking that the response of the unemployment rate to the variations that occur in the economic cycle is weaker, when the country has higher levels of informality. Furthermore, it is observed that informality in the region decreases in periods of strong growth and increases in periods of low growth. In other words, the possibility that citizens have to enter and leave the informal sector protects, in part, workers from situations such as the current one, mitigating the impact of said cycle on the unemployment rate. For example, in situations where an emerging market economy enters a recession, as workers who otherwise would have been employed can find informal jobs.

All this is possible thanks to the flexibility provided by the informal economy, but which, if it should be clear, could also be present, and it is in some economies, without the need for such a high degree of economic informality. In this sense, the flexibility of the labor market is a crucial factor in rebalancing the economy in response to shocks and, therefore, in promoting economic growth. But in some Latin American economies, labor regulations tend to be excessively rigid, so, as in other countries, the motivation comes from economic informality and the flexibility that accompanies it.

In accordance with these conclusions, the results indicate that labor market policies must strike a balance between equity and efficiency. For this reason, applying excessive regulation in the labor market, in the same way that it protects the employee more, discourages job creation, while disabling many low-skilled workers from entering the labor market. For this reason, the study, in the same way that it shows the great problem that the underground economy represents in the economy, shows the great strength that this can represent, in times of COVID, for certain countries.

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