Policy Opportunities and Challenges from the COVID-19 Pandemic for Economies with Large Informal Sectors

In the developing world, the informal economy can account for as much as 80% of the population. I focus on the urban component of informality, where both informal employment and informal enterprises are especially vulnerable to the pandemic-induced economic shock. I explain the complex nature of informality, some of the reasons for its persistence, and its interdependency with the formal economy, especially in the manufacturing sector, through global value chains. Large firms (whether MNEs or domestic firms) sub-contract considerable activity to informal enterprises, but this is precarious in character. I suggest the crisis provides the circumstances for greater active engagement with informal actors, by placing informal enterprises on par with formal firms within industrial policy. I propose integration and registration, as opposed to formalization, and the provision of state support without taxation. The role of the state is also crucial in matchmaking, creating incentives for GVCs to engage with informal actors systematically, and to reduce the transaction costs for informal actors in such engagement. These actions are likely to provide benefits in the longer run, even if they prove costly in the short run.

Keywords: informal enterprises, dual economies, urban poor, linkages, employment, policy

JEL Classifications: E26, O17, O19, O25