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  • The Informal Economy: A literature review

    Natasja VanderBergJanuary 2014

  • Table of Contents

    The Informal Economy: A literature review 0The Informal Economy: An Introduction 2Defining the Informal Economy 4The Informal Economy Today: Internationally, Nationally, Provincially, & Locally 5

    Internationally 5Nationally 5Provincially 5Locally 5

    Characteristics of the Informal Economy 7Legal vs. illegal work 7Cash Transactions 7Subcontracting 7Conditions of Labour 7Precarious Employment 7

    Demographics of the Informal Economy 8Poverty and the Informal Economy 8Newcomers 8Women in the Informal Sector 8Education 9

    Benefits & Negatives of the Informal Economy 10Benefits 10Negatives 10Wide Effects of the Informal Economy 11

    Theoretical Approaches to the Informal Economy 13A Negative View of the Informal Economy 13A Positive View of the Informal Economy 15Beyond the Either/Or of Positive or Negative 15

    Social and Public Policy Alternatives 18Support, not Punishment, to Promote Formalization 20

    Changing the tax system 20Changes to the social assistance system 20Improving support systems for newcomers 20Provide universal childcare 20Simplify formalization procedures 21Early intervention 21

    Key Questions for Further Research 22

    Bibliography 23

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  • The Informal Economy: An Introduction

    In his book Off the Books: The Underground Economy of the Urban Poor, Sudhir Venkatesh describes an interconnected web of informal economic activity in a low-income neighbourhood in Harlem, NY. The underground economy allows low-income persons to earn more than they declare. According to Venkatesh, participation in the informal economy is a means of survival for many.

    A spectrum of theories attempts to explain why some employers, self-employed persons and employees participate in the informal economy. Depending on the theoretical approach to the causes of the informal economy, which this literature review will explore, participation in the informal economy is viewed as voluntary or involuntary (or somewhere in between). In other words, participation in the informal economy is either an exit strategy chosen by the participant or the result of exclusion from the formal economy.

    Regardless of theoretical approach, it is generally agreed that participation in the informal economy has certain benefits but also serious drawbacks. Benefits of the informal economy include the ability for groups and individuals to form economic relationships outside of the bureaucratic red tape of formalizing a business and declaring taxes. As we will see, people often participate in the informal economy in an attempt to gain a livable wage and often dont make enough money to make formalizing their activities worth the time and effort it takes to do so. While participation in the informal economy may be or seem to be the only viable option for a worker or business owner, participation means that the persons is not offered the same rights and protections by the state as formal workers. In addition, they are not entitled to state benefits. Drawbacks of the informal economy identified in the literature include lack of: job security; guarantee of a living wage; and, entitlement to state benefits during periods of unemployment, among others.

    Research done by not-for-profits such as Community Links in the UK shows that participation in the informal economy has a complex effect that changes over time. In the short term, informal work helps people deal with periods of dire poverty, triggered by illness or loss of a formal job, by enabling them to pay for necessities. In the medium term, however, informal work leaves individuals outside the formal labour market, unable to access rights such as the minimum wage and sick pay, and may keep them in poverty. (Barbour and Llanes, 23). P who earn income within the informal economy do not pay into government programs such as the Canadian Pension Plan or Employment Insurance. Thus, working in the informal economy can be a solution to financial difficulty in the short term, but may cause financial precarity in the long term.

    Given the general agreement about the drawbacks of the informal economy, many scholars ask: How can the participation in the informal economy be reduced? If one sees participation in the informal economy as voluntary, one would promote stricter penalties for those who choose not to abide by employment and tax laws. On the other hand, if one views participation in the informal economy as the only viable means of survival for some people, then the answer to that question is more complicated, and potentially unsettles the assumption that it should be reduced.

    Front-line support workers in non-profit service organizations in the West End of Toronto suggest that low-income persons are engaged in informal economic activities in a

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  • variety of sectors. Some suggest that participation in the informal economy has increased in recent years. This perception leads to many questions: Is working outside of the informal economy a good choice for those who do so in the short and long terms? Is it a choice? How can the vulnerability of workers within the informal economy be minimized? Should and can the government and service agencies do anything to support persons and small businesses in transitioning to the formal sector?

    Due to the off the books nature of the informal economy, it is difficult to quantify participation in the informal economy. St. Christopher Houses informal economy project began with questions. In its research design, it seeks to gain information through qualitative research in the form of interviews with individuals and groups of persons. The project does not seek to quantify the scope or extent of the informal economy, but rather seeks to ask whether any steps can be taken to improve the economic lives of its participants. This literature review aims to describe the broader context within which this local discussion is taking place. Theorists have theorized about the informal economy and organizations and foundations across the globe have explored the issue within their own locale. This literature review will focus on theories and discoveries that can help shed light on the situation here in the West End of Toronto.

    This literature review will begin with a definition of the informal economy. After defining the term, we will briefly explore the scope of the informal economy, its characteristics and, finally, demographics of participation. We will then outline the negatives and positives of participation in the informal economy. Next, we will survey a number of theoretical approaches to the informal economy. These approaches attempt to answer the question: What are the causes to the informal economy? Each formulation of a cause implies a particular solution or set of solutions, which will be discussed in the conclusion of this literature review.

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  • Defining the Informal Economy

    Participation in the informal economy can take many forms, from an employee working under the table to a construction worker doing a job for cash. Many of us have participated in the informal economy in one way or another, as an employee, employer or consumer. The informal economy can be defined as non-participation in three broad areas where formal compliance is overtly defined by governments and their agencies:

    Taxation: e.g. income tax, sales taxes and payroll taxes Social Programs: e.g. Ontario Works, ODSP, EI, CPP etc., and Regulation: e.g. criminal code, provincial offences, bylaws and codes related to

    paid and unpaid work, commissions, credentials and business activityEarly definitions of the informal economy included a wide spectrum of activities

    from criminal, paid activities to non-monetized work, including work in the home, volunteer work and bartering. More recently, a narrower subcategory of the informal economy has been defined as the paid informal economy. The paid informal economy is understood as monetized exchange that is unregistered by or hidden from the state for tax, social security and/or labour law purposes but which is legal in all other respects (Williams, 2011, p. 25)

    In Shades of Grey in the Informal Economy, Jones, Ram and Edwards adopt a similar subcategory as their object of study. In their words: Such precision is a welcome improvement on some of the early definitions, which, by including all sorts of unpaid categories like domestic labour, tended to overload the concept to the point of meaninglessness (2006, pp. 357-358). In this definition of the informal economy, otherwise legal activities are done in the context of illegal labour practices such as violations to: minimum wage and vacation pay; health and safety regulations; laws related to hours of work, job security, written contracts, holidays; and immigration laws.

    There are many regulations and laws surrounding employment in Ontario: Workplace Safety and Insurance, minimum wage, laws surrounding vacation pay and sick days, and tax laws. Employers must abide by the regulations and laws and provide the employee a safe working environment and a decent standard of living in exchange for work. The regulations and laws offer, to some degree, protection to the employee. At the same time, the tax laws ensure that the state receives a share of the employers and employees income. Employees, self-employed persons, and employers who subject themselves to regulations and laws surrounding employment participate in what is referred to as the formal economy.

    Unfortunately, by narrowing the definition to a manageable concept, we do not escape complexity. A major part of this complexity is the blurred boundary between the formal and informal. One cannot draw a line between the informal and the formal, with the inf

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