Europe could stop fighting it and see if informal economy has lessons to teach

By | September 9, 2012

Wastepickers in Athens, Greece 2012

Scanning recent writing on the informal economic activity in the wake of the Great Global Recession brings to light the ongoing struggle to deal with it.  Is it good or is it bad? Will it help or is it hindering? Don’t forget the taxes being left unpaid by the economically challenged citizens trying to feed their children. The contradictory articles seem to imply that its perfectly alright for the unemployed in the third world to seek ways and means to earn a dollar but its evil and unthinkable for the same response to occur in the first.

Hoist by their own petard is the cliche that comes to mind, yet it seems as though the conflict is more due to the long established demonization of this natural behaviour, one that has documented benefits such as resilience and cooperation, thus few attempts are being made to bridge the chasm between the formal and informal or pause to understand if there may be some value for the future.

John Sullivan asks What Does the Informal Sector Mean for Global Economic Growth? where he offers insights from the situation in North Africa:

Most of the countries involved in the Arab Spring do not yet have the resources available to create the jobs that they promised. They lack the money to simply build new factories, and government sector employment is no longer the solution it was during the strongman days. Governments must mobilize the informal sector and give them a voice. […] The street vendors of Cairo have already spoken out by partnering with the Federation of Economic Development Associations to develop a draft law and begin working toward its implementation.

But from Europe comes writing whose word choices imply that the neighbourhood kid out to make some pocket money is as much of a tax dodging criminal as more shadowy members of society:

This informal economy is spreading almost to everywhere in the world. It does not only affect developing countries but it is also part of the everyday life of high-income countries, such as the EU member states. Entrepreneurs operate in the unofficial economy because they want to get free from the taxes and regulations that make official transactions unprofitable or unfeasible. Thus, the farmer who sets up a roadside stall selling produce is a participant, so is a construction company that does not report its income to the government in order to avoid meeting legal standards such as minimum wage. Parts of this informal economy also include the children who sell homemade lemonade outside their houses in summer, or their private French classes paid for by adults under the table.

Its a terrible virus, apparently, and its infecting our kids. In Greece – hardest hit of the eurozone nations – Prof Friedrich Schneider, who has researched the Shadow Economy, as he calls it, shares his point of view:

Schneider said that the greater the difference between gross and net income of citizens the more likely it is for the informal economy to deepen.  High social security deductions and taxes predispose individuals to seek ways of avoiding these costs. “No one is hiding taxes in order to save money. All who evade taxes want to gain something in the short term.”

A major prerequisite for the development of informal economy is the complex and complicated legal system. European countries are hyper-regulated by default and the more severe cases are on the periphery of the euro area and in the countries of the Eastern bloc. Corruption there is particularly strong. Schneider explained that the system should be simplified and facilitated.

The quality of services in the public sector can also affect the deepening or reduction of the informal economy. The more severe the procedures in the public sector, the greater the risk of avoiding the implementation of established procedures.

The European version is all about the formal structures, laws and regulations, taxes and services – sounds like a bureaucracy, while the very nature of the informal is the flexible and adaptable. Is it any wonder that its sprouting up in response to the perceived collapse of the global formal economy, as we saw in Spain last week?

I wrote the following 3 years ago, after reviewing the writing on the informal economy, then focusing primarily on the lower income demographic in the developing world:

Because as long as you lump together the activities of the people like selling hotdogs door to door (although buying it from a wholesaler informally), distilling wine for the village, keeping small shops within walking distance when towns are far away or even urban services ranging from garbage disposal to dishwashing to repairing shoes – with the “firms that are hiding from formal regulations and don’t want to pay taxes etc” any formal programs or activities, whether from the social and economic development angle or the corporate profitability angle are going to act at cross purposes.

Martha Alter Chen writes in “Rethinking the Informal Economy” that India stands out as an example where the informal economy has been accepted, acknowledged and now slowly being addressed by government policy. Not in order to dissolve it or remove it but to work with it simply because the incomes of far too many people are dependent on it and no formal systems can be put into place to take care of each and every corner of the country nor her billion citizens.

One can then take what seems to be working, called “creative, resilient and efficient” by Hart, quoted by Chen, and enable systems that support it further, fostering development and increasing success rates at the touchpoints where the informal and formal meet.

Perhaps there is a lesson here about flexibility and adaptability for formal, structured Europe and her economy, hurting as it is right now? After all, as the Jamaica Gleaner puts it, people have to spend all that money somewhere:

Everton McFarlane, deputy director general, said informal activity is being reflected in the formal economy via consumption and investment.

“If there was this informal sector that somehow was not being captured, then where are these people spending their money?” asked McFarlane.

“Are they not spending their money on agricultural goods? Would you not see that in the GCT sales? Are they not spending on electricity consumption? Are they not spending on housing?

In other words, the intersection of the formal and informal economy is not an island by itself that is divorced from the formal sector.  Whatever is taking place, people must consume.

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