How Productive is the Informal Sector?

“In Bolivia there are informals and there are idiots”
Luis Alberto Quiroga

The informal sector is often perceived as a sector for excluded, un-educated, low productivity workers who cannot get a “real” job. According to last week’s seminar on Informality in Bolivia organized by the Superintendencia de Empresas and CAF, this perception is quite misleading.

Fernando Landa from UDAPE presented the following table, which shows that the informal sector in Bolivia generates about 65% of GDP and accounts for about 67% of total employment. These numbers are very high compared to other countries, but what is really interesting about them is that they imply that the informal sector is just as productive as the formal sector: Two-thirds of workers generate two-thirds of GDP.

This is in contrast to countries like Chile, Costa Rica and Ecuador, where workers in the informal sector on average are only half as productive as workers in the formal sector. (In Panamá, however, informal workers are apparently substantially more productive than formal sector workers.)

The numbers refer to different years, and there may be problems related to differences in definitions, but even if they are only roughly right, they are striking. Workers in the informal sector in Bolivia have much less education and much less capital and natural resources to work with, so it is quite impressive if they are about as productive as workers in the formal sector.

Rolando Morales pointed out that about 90% of all businesses in Bolivia are informal, so it is not exactly a marginal sector. Rather, they constitute the heart of the Bolivian economy, and their decision to be informal is the rational decision given the huge penalties to formality in Bolivia.

Alejandro Mercado of IISEC suggested that we stop using the negatively loaded word “informals” and instead call them entrepreneurs, or even heroes, because they are the ones that make the economy work at all.

So, if the informal sector is so productive and well-functioning, why do the people working there earn only a fraction of what people in the formal sector earn? In urban areas, workers in the informal sector earn only 48% of the average income in the formal sector, despite the fact that they work more hours per week (2).

One explanation is that incomes are not properly measured in the informal sector. A family which runs a little corner shop, for example, can take out all the groceries they need without that counting as income, and a woman that runs an informal lunch/dinner service, makes sure to make enough food to feed the family too.

Once we compare consumption levels instead of income levels, the families of informal workers consume about 64% of the average consumption level for families of formal workers.

There is still a substantial difference, but it can be at least partly explained by the lower education level of workers in the informal sector (8.2 years, on average) compared to workers in the formal sector (11.7 years). There are also a much larger share of women and indigenous workers in the informal sector, although that shouldn’t count.

The remaining difference may be well worth the price to pay if you value flexibility, independence, spending time with your family, being your own boss, and not having to constantly deal with red tape and frustrating bureaucratic procedures.

Thus, we don’t have to feel sorry for the informals. Rather we have to feel sorry for the formal productive sector, which has to compete not only with the tax- and bureaucracy free informal sector, but also the completely distorted salaries of the public sector and the international development community.

Do you know of any other examples of beneficial Informal Sectors? Leave a reply below.

(*) Director, Institute for Advanced Development Studies, La Paz, Bolivia. The author happily receives comments at the following e-mail: landersen@inesad.edu.bo.
(1) Landa, F. & Yañez, P. (2007) “Informe Especial. Informalidad en el Mercado Laboral Urbano 1996-2006“. Working Paper. Unidad de Análisis de Políticas Sociales y Económicas, La Paz, Bolivia.
(2) Comparisons based on the 2005 MECOVI household survey.