Impact Of The Informal Economy On Development

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What is Informal economy?

Simply put the informal economy refers to those economic activities that are neither taxed nor monitored by a government and are therefore not included in that government's Gross National Product (GNP) However in literature this phenomenon is discussed using different concepts such as informal, unofficial, irregular, parallel second underground, underground, grey markets, subterranean, hidden, invisible, unrecorded, shadow, ghosting and moonlighting. Illegal or criminal activities such as drug dealing or prostitution have been excluded from this definition, as have exchanges of unpaid work. My paper is therefore prepared with this omission in mind.


“In many developing countries, unofficial economic activity (that conducted by unregistered firms or by registered firms but hidden from taxation) accounts to between a third and a half of the total. This share declines sharply as the economy develops. Despite the sheer magnitude of this unofficial activity, little is understood about its role in the process of economic development, and in particular about how important “officializing” these hidden resources might be for economic growth.” (Rafael La Porta and Andrei Shleifer pg 1)

Role of informal economy on development

A recent cross-country report presented by authors Rafael La Porta and Andrei Shleifer that appeared in the Brookings Papers on August 2008 aims to improve the understanding of the relationship between economic development and the informal economy. The report distinguishes between three alternative views of the role of informal economy in development. The Romantic View: According to this view unofficial firms are either actually or potentially extremely productive, and are held back by government taxes and regulations, as well as by lack of secure property rights and of access to finance. Pending the necessary legal reforms “four billion people around the world are robbed of the chance to better their lives and climb out of poverty, because they are excluded from the rule of law” (United Nations, 2008, page 1). If the barriers to officialdom are lowered and capital is supplied through micro finance, unofficial firms will register, borrow, take advantage of other benefits of official status, and by doing so expand and spark economic growth. The key aspect of this optimistic view is that unofficial firms are fundamentally similar to the official ones, but kept down by policy. In particular, unofficial firms should look similar to official firms with respect to characteristics not affected by government policies, such as the characteristics of entrepreneurs (e.
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