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Beyond Formality and Informality

by Basudeb Guha-Khasnobis, Ravi Kanbur, Elinor Ostrom

by Basudeb Guha-Khasnobis, Ravi Kanbur, and Elinor Ostrom

The constructed opposites of formality and informality have dominated the development discourse for more than half a century. They have anchored theoretical, empirical, and policy discussion in many disciplines as they have studied the development process. Despite this pedigree, the usefulness of the formal–informal dichotomy has constantly been debated in the literature which still does not provide any consistent definitions. Instead, it turns out that formal and informal are better thought of as metaphors that conjure up a mental picture of whatever the user has in mind at that time. Reviews have concluded that there are competing perspectives rather than a single dichotomy. Discussions of the formal and the informal have been enriched considerably by the literature of the past two decades on (self) organization of common property regimes, and by the push in some policy circles to extend property rights to groups of individuals who do not currently ‘enjoy’ such rights. 

Not surprisingly, the views on the entities that comprise the informal sector also differ greatly. In official statistics, different countries use the terms differently in detail even when they might mean the same thing in a general sense. The international official definitions, for example as codified by the ILO, have been expanding. The current official definition of ‘informal sector’ was adopted by the 1993 International Conference of Labour Statisticians based on characterizing an enterprise as informal. In 2003, guidelines were introduced to expand the definition to include informal employment outside informal enterprises, with an appropriate definition of the former. 

From the mass of alternative uses of the terms and alternative characterizations, we would like to highlight two strands that are particularly relevant for the current policy dialogue. The first strand is the notion of informal as being outside the reach of different levels and mechanisms of official governance and formal as being reachable by these mechanisms. This notion underlies many official definitions of ‘informal enterprises’ as those that are not registered and are legally outside the tax net. It also underlies many analytical investigations of enterprises and activities that operate illegally, in violation of formal state rules and regulations, even though informality and illegality are not considered to be equivalent in this notion. This notion also animates the lively policy debate on the extent to which the informal sector owes its existence to ‘overly constraining’ official regulations that lead to economic activity taking place outside this net. And, of course, this is also the dimension that best captures different views on the benefits or otherwise of extending the reach of official structures to where they currently do not reach (e.g. legal property rights), or of reducing this reach (e.g. labour regulations).

The second strand that can be discerned in the discourse has to do with the nature of organization. The informal is often identified with ‘lacking structure’ and the formal with ‘structured’—the term ‘unorganized sector’ is often used. In the policy discourse, the association of the informal with unstructured has been a powerful impetus for interventions that have often led to disaster. A striking illustration of this is the attempt to nationalize forests in Nepal, based on the analysis that deforestation was being caused by the inability of small local communities to prevent environmental degradation. In fact, as we now know, the local communities had better structures in place to deal with the deforestation that was the result of population and other pressures. These structures were not recognized, and were replaced by the formal state structures which proved to be ineffective and corrupt leading to even faster deforestation. The government in Nepal later reversed its earlier policy and started turning forests over to Forest User Groups. The opposite is true of the software industry of India, now recognized as a world leader. It flourished under the entrepreneurship of some highly skilled and far-sighted individuals, quickly becoming the fastest growing export sector of India. Until recently, India had a highly regulated economy, but the government was surprisingly noninterfering as far as the software sector was concerned. Even until very recently, the industry’s output and exports were categorized as ‘miscellaneous’ in India’s national accounts (as opposed to being called ‘manufacturing’ or ‘services’), such was the degree of informality. The initial abstinence of the government was indeed a blessing in disguise. 

These two dimensions—the reach of official governance and the degree of structuring provide an initial entry to a framework for capturing the many definitions that abound in the literature. The distinction between the two dimensions is not redundant. This is illustrated for example by the detailed empirical work showing the highly structured interactions within groups that manage common-pool resources, far removed from any interaction with official governance. Moreover, for similar levels of connection with the state tax system, we see enterprises with very different types and complexities of internal structure. The two dimensions do, however, interact. On the one hand, attempts by official governance to extend its reach, for example, by widening a regulation to an area where it was not previously applied, will in general lead to a response that may move some activities outside the reach of the regulation (legally or illegally). In so doing, it may well change the structuring of the activities that escape the official net. It has been observed, for example, that relationships within illegal activities are often very highly structured, sometimes more so than in legal activities, as a response to the risks of the activity in question. By the same token, some types of (re)structuring of activities make official intervention easier, or may even be predicated by the nature of the official governance frameworks.

On the policy front, the issue is not one of ‘greater’ or ‘lesser’ reach of government being better in general, as it is so often characterized, but one of the ‘right’ reach of government. This ‘right’ reach has to take into account (1) the objectives of intervention, (2) the implementation of the intervention, and (3) the response of the structuring of activities to this intervention (it being recognized that ‘more’ or ‘less’ structured does not necessarily correlate with ‘good’ or ‘bad’).

The objectives of intervention can then be seen under two broad headings: (1) Improving the wellbeing of the poor and of society at large by improving the capacity of individuals to self-organize and address their collective action problems by themselves and (2) Improving the well-being of the poor and of society at large by addressing the problems that arise when individuals interact through markets. 

These two objectives may be seen as addressing group failure and market failure, through better operation of self-organized groups and through better operation of markets. Of course, it goes without saying that the two objectives interact, with outcomes in one influencing outcomes in the other. The myriad of interventions that we actually see in practice can be assessed in the above framework. But why do some interventions achieve their objectives while others do not? A key step is to focus in on the goals of such efforts and the specificities of time and place. We have repeatedly learned from many studies of policy processes, that no single institutional arrangement works across diverse policy areas or even diverse subtypes within a broad policy area. Copying interventions that worked well in one country may lead to a major failure in another country.

We would propose, therefore, especially in light of official statistical conventions already adopted, that the formal–informal continuum apply strictly to the continuum between relatively high and relatively low levels of the reach of official governance mechanisms, suitably specified and measured in each context. This relates the terminology directly to the policy discourse on the nature and extent of government intervention in economic activity. However, even in this case we would prescribe a health warning—informal does not mean unstructured and chaotic, and does not invite policy intervention on those grounds! More generally, we would keep the ‘reach of government’ as a purely descriptive term, leaving the issue of whether it is a good thing or a bad thing to be decided on a case by case basis, taking into account the self organizing structures that communities are capable of producing, within or without the reach of official structures. We should move beyond formality and informality, and tackle directly the policy interventions that will help the poor to unlock their potential through groups and through markets.

This article draws on Chapter 1 of ‘Linking the Formal and Informal Economy: Concepts and Policies’ edited by Basudeb Guha-Khasnobis, Ravi Kanbur and Elinor Ostrom. Oxford University Press, September 2006. See also ‘Informal Labour Markets and Development’, edited by Basudeb Guha-Khasnobis and Ravi Kanbur. Palgrave Macmillan, July 2006.

Basudeb Guha-Khasnobis is a Research Fellow at WIDER. His main areas of research include trade and development, role of financial sector in growth, informal sectors, food security, and gender issues. He was the coordinator of the EGDI-WIDER Conference on Unlocking Human Potential: Linking Informal and Formal Sectors, 17-18 September 2004.

Ravi Kanbur is T.H. Professor of World Affairs, International Professor of Applied Economics and Management, Professor of Economics at Cornell University, and a member of the Expert Group on Development Issues (EGDI) of the Swedish Ministry for Foreign Affairs. He was previously Chief Economist for Africa at the World Bank.

Elinor Ostrom is Arthur F. Bentley Professor of Political Science; CoDirector, Workshop in Political Theory and Policy Analysis; Co-Director, Center for the Study of Institutions, Population, and Environmental Change (CIPEC), Indiana University; and, a former member of the Expert Group on Development Issues (EGDI) of the Swedish Ministry for Foreign Affairs.

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