Informality, socioeconomic development, and the COVID-19 Pandemic: Challenges and opportunities in Emerging Market Economies

Introduction

Informal Employment (IE) is a deep structural socioeconomic issue embedded in all economies and countries worldwide. IE nurtures the informal economy, also known as the informal sector, encompassing all labor and business activities hidden from regulatory authorities. According to the World Bank (2019), the informal sector accounts for about one third of global GDP and between 60 and 70 percent of employment in emerging market and developing economies. Likewise, one-half of the world’s informal output, and more than 90 percent of IE, are located in emerging market economies (World Bank, 2019).

Addressing the causes of IE in EMs is a complex and multifaceted subject. This policy brief aims to lend a better understanding of the stakes in times of socioeconomic crises and prescribe key policy recommendations for policymakers and the private sector. More specifically, we analyze informality from a financial and governance perspective through the prism of the current Covid-19 pandemic in EMEs (particularly, South Asia and Latin America). On the one hand, EMEs have faced difficulties in providing economic stability due to financial gaps in national budgets. On the other, the informal sector has run parallel to governmental capacities, falling outside the scope their stopgap measures.

What follows is an analysis on how EMEs should face development challenges related to informality in their distinctive contexts.

Overview of Informal employment in Emerging Market Economies

A cross-country analysis of IE paints a picture of wide heterogeneity across EMEs, with South Asia (SA) bearing the highest average share, allocating around 42 percent of the world’s informal workers. The top four EMEs with higher percentage of informal employment¹ are Bangladesh (91%), India (80%), Indonesia (76%) and Pakistan (71%), see Figure 1. In South Asia, the size of the informal sector output generated relative to GDP stands at 30 percent (slightly lower than the 35 percent of EMEs average).

Likewise, in Latin America and the Caribbean (LAC), informal sector output is substantial, equivalent to 34 percent (on average) of the region’s GDP in 2016. While in Chile, the amount of informal output accounted for approximately 16 percent of its GDP, in Bolivia, Peru, Colombia and Mexico, it stretches to nearly 60 percent (Figure 1). Taken together, 62 percent of total employment in LAC belonged to the informal sector and 38 percent were self-employed.

Figure 1. Percentage of informal employment in EMs (out the total 100 world ranking)
 The impact of Covid-19 in EMEs with high levels of informality

In 2020, the Covid-19 pandemic exposed the expansiveness of informality as national lockdowns bore down on IE sectors, especially in EMEs. As of April 22, 2020, about 1.1 billion informal economy workers were in full lockdown (ILO, 2020). Staying home proved untenable for those who live on daily income, at or below the poverty line, and who, in addition to not having savings to lean on during the pandemic, are largely without social security guarantees. National and regional lockdowns have been enforced in most of the EMEs analyzed here, with India shouldering the highest number, and Peru the lowest (see Figure 2). Together, these EMEs account for 35 percent of the global population.

Figure 2. Number of people Lockdown in EMs with higher rates of informal employment

Paradoxically, EMEs with the highest informality rates are the ones with the largest populations under lockdown measures. As a response to the Covid-19 pandemic, EM governments have made significant investments not only in healthcare systems but in providing relief packages for companies and those most in need, including informal workers. States have provided cash transfers or aid in kind to lower the rise in poverty, expanding inequality and public safety issues. These general and fiscal responses have accounted for as much as 11% of GDP in the case of Brazil, and on average 5,6% of GDP for the EMEs studied in this article. Indeed, as the Covid-19 pandemic rages on, expenditures keep rising (see Figure 3). For instance, the IMF projection for EMEs government deficits increased 1.5 points between April and June in 2020.

Figure 3. Fiscal response to Covid-19 (as a percentage of GDP)

Governments face a possible liquidity crunch caused by the large expenses they incurred in the short term to get a handle on the Covid-19 crisis. Hence, the decision over whether to issue new debt to improve liquidity or to reduce the expenditure—the first option enables governments to secure enough cash to continue launching stimulus packages (at the expense of default risk or fiscal pressure against future policies). The second would lead to a reduction in the subsidies and capacities to provide aid (to the detriment of people living in poverty, potentially delaying the recovery).

In fact, countries around the world are taking on extra public debt to shore up enough resources to fight the pandemic. Specifically, EMEs are looking for alternatives either with debt relief services with multilateral banks such as the International Monetary Fund (IMF), the World Bank, the Asian Development Bank (ADB) and the Inter-American Bank of Development (IADB) or issuing bonds in international markets. For example, since the beginning of the pandemic, Nigeria, Colombia, Pakistan and Chile have received loans from the IMF. Also, Chile, Colombia, Indonesia, Mexico, Philippines and South Africa have issued government bonds to raise resources to fight the Covid-19 pandemic (see Table 1).

Table 1. Debt issued by EMs related to the Covid-19 pandemic (in billion USD) as of July 3^rd, 2020

Source: Authors’ compilation based on the IMF, the World Bank and several news outlets.
Note: Information as of July 3rd, 2020.

Informality beyond economic boundaries

Informality is deeply entangled in EMs and represent an array of challenges. We tested an univariable regression between the informal employment rate and the Human Development Index (HDI) scores (UNDP, 2019) for each of the EMs studied in this report, obtaining significant statistical findings. Results expose that EMs with the higher informal employment rates tend to have lower human development standards contained in the HDI. Being the ones with larger populations such as India, Pakistan and Bangladesh, the countries with the lowest scores in human development and the highest levels of informal employment (see Figure 4). On the contrary countries like Argentina and Chile have lower IE rates and higher HDI in comparison with the other EMEs evaluated in this report. These empirical results suggest fundamental socioeconomic Human Rights like the access to education, health and guarantee of descent income might be threatened in EMEs.

Figure 4. Regression between the percentage of informal employment in EMEs and their corresponding value of the latest Human Development Report (UNDP, 2019)
Incentives to promote formal employment:
It behooves EMEs to develop strategies to promote formal employment creation, hand in hand with the private sector. Here are some recommendations different institutions should consider:

Policy recommendations to tackle informality and improve human development standards

1. Reduce the cost of employment without compromising working conditions. Some countries levy taxes and parafiscal charges per employee¹⁰. These are costs should be more flexible in order to reduce total costs per employee for employers, a recurring reason why employers in EMEs do not engage in formal employment contracts.
2. Employment support for small companies. Small and medium enterprises (SMEs) struggle most to cover the costs associated with formal employment. These companies rarely earn enough revenue to cover a complete formal payroll, engaging with different contractual arrangements so as to skirt the complete cost of a formal employee. Governments should create tax incentives for SMEs and entrepreneurs to promote formal employment.
3. Reducing regulatory burdens for entrepreneurship under formal and flexible economic arrangements. Although entrepreneurship is a well-known development strategy, the creation of new enterprises under proper regulation standards, will lead to the creation of new formal employment.

Public Sector Institutions: The following governance mechanisms would further alleviate the crises of IE in EMEs.

1. EMs government institutions should encourage multi-stakeholder involvement to improve employment quality, secure labor rights, and guarantee social protection.
2. Flexible taxation and regulatory mechanisms must be enforced or created to promote formalization across regions and industries. Political leaders and legislators should include this subject in national development agendas.
3. Awareness and research programs related to formalization and socioeconomic welfare should be promoted in each country at national, regional and local levels. Other looming threats beyond the Covid-19 pandemic include climate change, future resource scarcity, new zoonotic viruses, among others. Making human vulnerabilities central will draw in novel solutions to the realities of the informal economy.
4. Articulate National policies with the Sustainable Development Goals (SDGs) of the United Nations. The SDGs holistic and interconnected objectives provide an adequate and integrated agenda for development.

Conclusion

EMs are fragile contexts—a cause and effect of the high rates of informal employment. The Covid-19 pandemic has exposed risks associated with the informal labor force in relation to poverty, inequality, and the higher cost it presents. Job formalization is a smart and appropriate solution to ensure long-term socioeconomic arrangements whose purpose must be the support of the public welfare. These countries account for a significant proportion of the global community. We must act not only on their behalf, but for the world economy as a whole.

Authors

Juan Pablo and Soraya, former research interns at the Emerging Markets Institute (EMI) at Cornell University, directed by Professor Lourdes Casanova. Now liaisons between Universidad de los Andes in Bogotá, Colombia, and the Emerging Markets Institute.

Juan Pablo Casadiego	Soraya Quiroga
Alumni of the Management School at Universidad de los Andes, Colombia Email: jp.casadiego10@uniandes.edu.co	Management & Law student at Universidad de Los Andes, Colombia Email: as.quiroga10@uniandes.edu.co

Further readings

United Nations. (2020). The Impact of Covid-19 on Latin America and the Caribbean (Policy Brief). Retrieved from https://www.un.org/sites/un2.un.org/files/sg_policy_brief_covid_lac.pdf

Global Economic Prospects: Darkening Skies (English). Washington, D.C.: World Bank Group. https://documents.worldbank.org/en/publication/documents-reports/documentdetail/178651547175676426/global-economic-prospects-darkening-skies

Transparency International. (2020). Coronavirus sparks high risk of corruption across Latin America. Retrieved from https://www.transparency.org/en/press/coronavirus-sparks-high-risk-of-corruption-across-latin-america

References

Chen, M., & Doane, D. (2008). Informality in South Asia: a review. Background paper for the Swedish International Development Cooperation Agency (Sida), Unpublished Working Paper.

Gasparini, L., & Tornarolli, L. (2009). Labor informality in Latin America and the Caribbean: Patterns and trends from household survey microdata. Desarrollo y Sociedad, (63), 13-80.

International Labour Office (ILO). (2018). Women and men in the informal economy: A statistical picture (Third edition). https://www.ilo.org/wcmsp5/groups/public/—dgreports/—dcomm/documents/publication/wcms_626831.pdf

Goldar, B., & Aggarwal, S. C. (2012). Informalization of industrial labor in India: Effects of labor market rigidities and import competition. The Developing Economies, 50(2), 141-169.

Ordoñez, J. C. L. (2014). Tax collection, the informal sector, and productivity. Review of Economic Dynamics, 17(2), 262-286.

UNDP (2019), Human Development Report 2019: Beyond Income, Beyond Averages, Beyond Today – Inequalities in Human Development in the 21st Century, UN, New York, https://doi.org/10.18356/838f78fd-en.

World Bank. (2019). Global Economic Prospects: Darkening Skies (English). Washington, D.C.: World Bank Group. https://documents.worldbank.org/en/publication/documents-reports/documentdetail/178651547175676426/global-economic-prospects-darkening-skies

¹ All the informal employment percentages presented in this document are the total of non-agricultural employment.

² All data retrieved from the IMF lending tracker: https://www.imf.org/en/Topics/imf-and-covid19/COVID-Lending-Tracker Accessed on July 3^rd 2020

³ All data retrieved from the World Bank website: https://www.worldbank.org/en/about/what-we-do/brief/world-bank-group-operational-response-covid-19-coronavirus-projects-list Accessed on July 3^rd 2020

⁴ Source: Diario Financiero. Retrieved from: https://gestion.pe/mundo/internacional/chile-recauda-unos-us-2000-millones-en-mercados-externos-para-luchar-contra-el-coronavirus-noticia/ Accessed on July 3^rd 2020

⁵ Source: El Colombiano. Retrieved from: https://www.elcolombiano.com/negocios/economia/colombia-emite-2500-millones-de-dolares-en-bonos-globales-DD13102247 Accessed on July 3^rd 2020

⁶ Source: Wall Street Journal. Retrieved from: https://www.wsj.com/articles/saudi-arabia-markets-dollar-bond-to-plug-spending-gap-11586959815 Accessed on July 3^rd 2020

⁷ Source: LatinFinance. Retrieved from: https://www.latinfinance.com/daily-briefs/2020/4/27/interview-mexico-goes-for-cash-before-bond-market-gets-crowded Accessed on July 3^rd 2020

⁸ Source: Reuters. Retrieved from: https://www.reuters.com/article/health-coronavirus-indonesia-bonds/update-2-indonesia-sells-asias-first-50-year-dollar-bond-to-fight-pandemic-idUSL4N2BV0XC Accessed on July 3^rd 2020

⁹ Source: ABS-CBN News. Retrieved from: https://news.abs-cbn.com/business/05/31/20/philippines-borrows-455-billion-for-covid-19-response Accessed on July 3^rd 2020

¹⁰ In most cases such taxes contribute to welfare governmental programs. However, sometimes they are also transferred to other type of national budgets expenditure.