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THE WORLD BANK GROUP A World Free of Poverty

- Overview
- Concept of Informal Sector
- Measuring the size of Informal Sector
- Self-Employment and Business Development
- Labor Market and Tax Regulations
- Coping Strategies and Exclusion
- Corruption and Governance
- Country Specific Information

        The transition from central planning to market economy was characterized by a wide range of reforms that changed the nature of the labor market. Prior to transition labor markets in East European and Former Soviet Union countries were totally regulated and jobs were protected, they lost their risk-free and equity-protection characteristics with the start of macro-economic and structural reforms . However, the conditions of the emergence of the informal sector have been quite different across the countries in the region. Two patterns characterized by different size and nature of the informal sector can be defined.

        In the East European and Baltic countries, the transition was characterized by large-scale re-allocation of jobs between sectors and by rapid development of the formal (official) private sector. As a result, the informal market in this part of the region is smaller, comparable in its size to informal economies in developed market countries. Within this group of countries, the substantial part of the informal labor market is constituted by self-employed and small firms . The typical examples of sources of informality in these countries are tax evasion and avoidance, corruption in business services, avoidance of registration, and escaping labor and other regulation by businesses. Informality presented by unregistered private enterprises (usually small) and unregistered survival-type activities (e.g., low-profit street trade, subsistence farming, low-paid casual jobs, etc.) constitute a relatively small part of the informal labor market. In these countries , the main reasons for the informal activities are the lack of regulation for small businesses or, on the contrary, excessive labor market and tax regulations.

        In the Former Soviet Union (FSU) countries (excluding the Baltic states), the labor markets are characterized by a degree of informality that changes their nature. The size of the informal labor market in some FSU countries is larger than the official economy and in most of the countries of the region it constitutes more than one-quarter of the total labor market. Characteristic examples of informality in this part of the region are survival activities that are created by coping strategies developed by families to compensate for low wages or wage arrears in the formal sector � such activities as subsistence farming, moonlighting or second jobs, part-time jobs, casual jobs, multiple job-holding, short-term jobs.

        The size of the labor market in the FSU countries and the fact that it is skewed to the survival type of activities, created the situation when informality is not a section of the labor market any more but is a major characteristic of it. The division between the formal and the informal sectors becomes almost nonexistent, and various forms of informality can be found within the formal sector: underemployment of many of the formal sector employees forces them to engage in informal activities while keeping full-time positions in the formal sector; widespread corruption in government services distorts government sector and private-public interface; capture of regulatory and policy processes by vested interests (state capture) blocks those positive developments in the area of policy and regulatory reforms that could break status-quo that is beneficial for the interest groups. Widespread corruption and inefficiencies of government institutions lead to increased risks and lower expected returns for businesses in the formal sector and thus push them in the informal sector.

        Because informal sectors are so diverse in different countries, the concept of informal sector is difficult to operationalize. The existing operational definitions are mostly based either on labor force status or work characteristics of individuals or on different characteristics of the enterprise or the workplace. Definitions that are used for measuring the size of the informal sector also vary across countries. Besides estimates of self-employment and survival activities, a few indicators are available. The first definitions of informal sector were introduced by the International Labor Organization (ILO) in 1972, and since then a number of definitions were offered by different authors as well as by the ILO itself.

        Several authors presented methods of indirect measurement of the size of the unofficial economy in transition countries. S.Johnson, D.Kaufmann and A.Shleifer measure the size of the unofficial economy in transition countries by estimating the gap between countries' official GDP and the GDP calculated using data on electricity consumption. R.Yemtsov evaluates the size of the informal sector in Georgia through the estimate of households� unreported income.

        Besides the current problems related to the lack of either workers� protection or business regulation, there is a growing concern related to the long-term consequences of under-employment in transition economies. Long periods of low-productivity employment or intermittent and casual activities erode worker�s ability to reenter the formal sector. Concern of exclusion of some groups of the society are growing as workers in the informal sector are not able to acquire the knowledge and skills needed in the market economy.