The informal economy is the set of economic activities carried out by workers and economic units that are not covered, or are only partly covered, by formal arrangements such as business registration, tax collection, labor law and social insurance. A street vendor without a trading license, a domestic worker paid in cash, a family farm that sells its surplus at a local market and a small workshop with no written employment contracts are all typical participants. The great majority of this activity is lawful in itself; what makes it informal is that it happens outside the systems through which states record, tax and protect economic life.
The term is distinct from criminal activity. Drug trafficking or smuggling may be informal in the sense that it is unrecorded, but statisticians and labor economists generally treat illegal production as a separate category. The informal economy also overlaps with, but is wider than, the shadow economy concept used in tax research, which focuses on income deliberately concealed from the authorities.
Origins of the concept
The phrase informal sector is usually credited to the anthropologist Keith Hart, whose fieldwork on urban self-employment in Accra, Ghana, was presented in 1971 and published in 1973. The International Labour Organization (ILO) adopted the idea in its 1972 employment mission to Kenya, which argued that small unregistered enterprises were a source of livelihoods rather than a temporary leftover of underdevelopment. Over the following decades the focus shifted from the sector, meaning a set of enterprises, to the wider informal economy, which also counts informal jobs inside formal firms and households.
In 2015 the International Labour Conference adopted Recommendation No. 204 on the Transition from the Informal to the Formal Economy, which remains the main international policy reference. It asks governments to make registration simpler, extend social protection and avoid treating informal workers as offenders.
Measuring the informal economy
Because informal activity is by definition poorly recorded, it is estimated indirectly. Labor force surveys ask workers whether they have a written contract, pension contributions or paid leave; enterprise surveys ask whether a business is registered and keeps accounts. National statistical offices also try to include informal output in gross domestic product (GDP), so that it is not simply missing from the national accounts.
ILO estimates published in 2018 put informal employment at roughly six in ten of the world's workers, with much higher shares in parts of sub-Saharan Africa and South Asia and much lower shares in high-income countries. Informality is closely associated with low earnings, and many people living below the international poverty line earn their income informally. Estimates vary widely by method, so figures for any single country should be read with care.
Money and payments in the informal economy
Informal businesses tend to run on cash, short-term trade credit and personal trust. Many owners have no business bank account and keep savings at home, a habit sometimes described as mattress cash. Credit often comes from rotating savings groups, family members or moneylenders rather than banks, a pattern described in the entry on informal banking.
Cross-border flows follow the same logic. Migrant workers employed informally abroad send money home through licensed operators, but also through hawala and other informal value transfer systems, particularly where formal channels are expensive or require documents the sender does not have. Remittances received by households in turn finance many small informal enterprises.
The growth of mobile money since the late 2000s has given many informal traders a first digital account, and is a central theme of financial inclusion policy. A digital transaction history can later support credit scoring, but it also makes income more visible to tax authorities, which some traders resist.
Policy and compliance issues
Governments approach informality from several angles. Tax authorities see a narrow tax base; labor ministries see workers without pensions or injury cover; central banks see weak transmission of monetary policy when much activity bypasses banks. Common responses include simplified tax regimes for micro-enterprises, low-cost registration, and incentives to accept electronic payments.
For financial institutions, a large informal economy complicates know-your-customer checks, because customers may lack payslips, tax returns or formal addresses that show the source of wealth. Regulators guided by the risk-based approach of the FATF generally allow simplified due diligence for low-value accounts so that informal workers are not excluded. At the same time, large cash-based sectors can conceal laundering, and banks must distinguish ordinary informal earnings from structuring or proceeds of crime.
Criticism and debate
Economists disagree about whether informality is mainly a choice or a constraint. One view holds that firms stay informal to avoid taxes and regulation; another stresses that many workers have no access to formal jobs at all. Critics of aggressive formalization campaigns, such as sudden currency withdrawals or cash restrictions, argue that they can damage livelihoods faster than they create formal alternatives.