Formal-informal economy linkages

Abstract

The persistence of high levels of unemployment, poverty and inequality are widely recognised as major socio-economic challenges for South Africa. The informal economy is often seen as an important component in expanding economic participation. However, the conceptualisation of what this practically means is not always played out. The expansion of the informal economy can have a positive effect on poverty if it arises as an off-shoot of a rapidly growing formal sector. It can reflect worsening poverty where it is stimulated by a collapsing formal economy or alternatively is caused by firms seeking to evade the regulatory and tax net. In SA, the formal economy dominates, and both output and employment are growing more rapidly than in the informal economy. In this situation, the informal economy does not appear to be dragging incomes down. But will informal economic activity be stimulated or crowded-out by a rapidly expanding formal economy? If the formal economy continues to expand, might informal activity grow at a faster, similar or slower pace? Might informal activity even shrink as the formal economy expands? There is no deterministic answer to this question. A number of variables will affect the respective growth of formal and informal activity. This paper offers a suite of linkages between formal and informal economic activity that need to be better appreciated. In reality, there is much inter-twining of informal and formal activity and this needs to be understood. Moreover, the concept of informality is not so clear:what is the informal sector? Many researchers say you know it when you see it, but it can?t be defined. This is not adequate.