Formal and Informal Economic Activities - Essay Example

Informal economy Informal Economy Introduction Formal economic activities themselves give rise to the demand for informal services. Informal sector encompasses a wide spectrum of activities – some legal and necessary, but many illegal and undesirable. It contributes to the economic activity and part-time employment generation in a significant way. In view of its very nature, which is by and large, arrangement of private services among citizens and unregistered businesses, it is practically difficult for governments to monitor, control or stop these activities. Governments all over the world are concerned about the informal economy running in parallel with the formal economy - with the legal activities escaping the tax net, and the illegal activities hoodwinking the law enforcement agencies. Hence one comes to accept the fact that in any society with a formal economy, the informal economy exists too. Definition and explanation “The hidden or informal economy is usually taken to mean any undeclared economic activity” (Grabiner, 2000). An economic activity remains undeclared either for the purpose of evasion of taxes or because it is prohibited by law. Informal economy is thus a burden on the state, since the major part of it is illegal and even when it is legal, it leads to tax evasion or undue claims by the so-called unemployed on social security system like unemployment / medical / other benefits. Undisclosed income or black money may be put to fuel further growth of informal activities, because it cannot be openly used for any legal purpose. Much of the informal economy is a simple private arrangement between service seekers and service providers, for a perfectly legal activity. Examples of this may be moonlighting in the construction sector, consulting in professional services sector, seasonal labour in farm sector etc., all paid for by cash-in-hand. To the extent these legal activities go unreported to the authorities, they form a part of the informal economy. Coming to the illegal activities, which obviously will not be reported to the authorities, they may be financed by the undeclared profits of legal businesses (Grabiner, 2000, p.1). Trading in smuggled goods / prohibited substances like drugs, gun running, trafficking, exhibition of prohibited cinematographic works (pornography) etc. are common examples of illegal and criminal activities in the informal economy. To add to this, there are many devious ways by Informal economy 2 which black money is generated, exploiting the loopholes in the framework of legal economic activity. For example, under-invoicing of imports to cheat on customs duties, or over-invoicing of exports to claim export subsidies, are two of the common sources of generation of black money. To facilitate completion of such transactions, further illegal methods are adopted like fund transfer through ‘hawala’ route, whereby money paid abroad by one person to another in one currency, is settled locally in another currency, all outside the ambit of legal scrutiny. Once again, cash-in-hand pays for all this. One thus notes that informal economic activities have cash as the main medium of exchange. Rural informal economy It was reported that the rural informal economy (legal) is, “…characterized by small and declining populations, great and widespread poverty, and persistent downward trends in earnings and rural income” (Edgcomb et al., 2004, p.6). In such communities, informal enterprise to engage in several small time activities to earn an extra bit of income over and above the normal (agricultural or ranching) activities, has become a way of life. Bookkeeping, golf course cook, tarring roads, forest seeding work etc are some of the works usually undertaken in the informal economic sector (ibid., p.22). Such activities are conveniently and expertly ‘layered’ between a regular job and a variety of non-regular jobs, with a view to minimize the ‘down-time’ or unengaged period. This is a simple economic necessity and a fact of life. Urban informal economy Reporting on the findings of Sassen (1997), researchers point out that the ‘highly capitalized and specialized service sector’ of the formal urban economy draws ‘low wage informal workers for low-end service jobs’ (Losby et al., 2002, p.25). When such businesses relocate to city neighbourhoods for any reason like rising costs etc., such relocation itself would generate further informal economic activities, since these neighbourhoods may be poorly developed. It is reported that the US households use informal services for up to 36% for different needs (ibid., 2002, p.29). They also bring out interesting statistics which point out that the higher the level of education / skill a person has, the lower is the likelihood of his or her employment in the informal services (ibid., p.30) Informal economy 3 Industry and informal economy Construction industry provides a typical example of informal employment in areas such as painting, carpentry and masonry. It also provides an opportunity for apprenticeship wherein the worker graduates from unskilled level to a skilled worker, over a period of time. Even in other formal sectors of industry like the information technology, auto repair shops, furniture shops etc., informal employment exists (ibid., p.26). More and more of the manufacturing companies are concentrating on their core businesses and subcontracting peripheral activities like security, repair & maintenance of machinery, buildings, routine cleaning of offices etc. Subcontractors employ informal hands as a matter of routine practice to avoid expenses on long term and regular employment. Cities and informal economy At a conference held in Durban, which brought together informal trade representatives from Durban, South and Central Africa and Brazil, delegates pointed that the informal sector was the most promising source of new jobs…while the formal economy was not able to keep pace with the demand for jobs….a number of city governments were drawing up plans to help the healthy growth of these activities by providing training, infrastructure and bank finance….and at the same time eliminating formal businesses from using the informal traders as low-paid ‘fronts’ (Alan Cooper, 2006). Mexico city had over 200,000 (1992) street vendors selling a myriad of things from food to electronics. The dependence of their families on this informal sector for their survival and the self-employment this had spawned could not be ignored. Efforts to declare them as illegal were drowned in praise, which pointed out “…street vending as a reliever of social tension, an alternative employment that closes the door to poverty and opens the possibility of new economic perspectives that come to better the quality of life.” (Cross, 1995). Quite clearly, informal sector is here to stay and grow, and governments have to find new ways to legalise it, so long as its activities are within the four corners of law. Linkage to formal economy In all the examples discussed above, it is apparent that the informal activities co-exist or in fact, are generated out of the formal economic activities. Reasons attributed for this phenomenon are shifting emphasis from manufacturing to services and increase in self- Informal economy 4 employment opportunities especially in small businesses. Decline in manufacturing activities is leading to loss of formal employment, which in turn prompts the unemployed to engage in part-time cash-in-hand jobs. Conclusion Informal economic activities, especially the legal ones are a fact of life and arise directly as adjuncts to the formal economic activities. In rural areas, they form an important source of additional income for families and consist mostly jobs in agriculture or ranching activities; in urban areas, they are generated as a result of large scale shifting of industrial activity to neighbourhood areas on the one hand, and due to the increasing importance of services over manufacturing. Within the industrial sector, construction industry, IT services, outsourcing of routine menial jobs through subcontracting etc. are some of the contributing factors. Some business houses also use legal but undeclared profits, to run illegal activities for extra profits. Large cities all over the world witness informal economic activities in a significant way, selling goods, which are the products of the formal businesses. References Cooper A. (2006), Durban’s informal economy is bigger business than you thought, retrieved March 20, 2007 from: http://72.14.235.104/search?q=cache:T4TUdj5KsV4J: www.durban.gov.za/eThekwini/Business/business_news/bigger_business/ view+informal+economy&hl=en&ct=clnk&cd=65&gl=in Cross J.C. (1995), Formalizing the informal economy: The case of street vendors in Mexico City, American University in Cairo, retrieved March 2, 2007 from: Edgcomb E.L., Thetford T (2004), The informal economy: Making it in rural America, FIELD, The Aspen Institute, Washington, DC. Grabiner Q.C. (2000), The informal economy, HM Treasury, London. Losby J.L., Else J.F., Kingslow M.E., Edgcomb E.L., Malm E.T., Kao V (2002), Informal economy literature review, ISED Consulting, Newark and Research and The Aspen Institute, Washington DC. Williams C.C. (2005), Informal economy, Small businesses in the informal economy: making the transition to the formal economy, University of Leicester Management Centre. Read More