The informal economy, employment and development

The approach of summer in the UP Diliman area where I have spent a large part of my life reminds me of the rustic life and its benefits.

In the month of March, the caimito – the succulent native fruit known as star apple otherwise – is in season. Excess supply of the fruit finds itself along intermittent stretches of the Katipunan avenue at the back of UP and the home office of the MWSS where the vendors ply their commerce of the seasonal fruit as long as the harvest lasts. Since I love the fruit, the sight of them yields pleasurable thoughts.

Then reality sets in. The UP and the neighborhood of large open spaces of government lands have become the haven of squatters, known today as “informal settlers.” The public lands intended for public use such as the integrated government center have been transformed as receptacles of poor migrants from the provinces. What belongs to all belongs to those who also squat.

What is the informal economy? The informal economy is a collective term for many low productivity transactions in the economy. The prices of services and the rules of doing business transactions are not governed by rules determined by law and public policy. The transactions happen through personal dealings among participants. In short, the informal economy is outside of the organized manner of doing business in the modern national sector of the economy. It was common before to use the term underground economy.

The informal sector is the employment “sponge” of the larger economy. Those who cannot find a livelihood as part of the organized economic activities often end up as participants in this low income sector. Such condition of life that affects the participants in this segment of the economy often persists over a long period.

We are linked to the informal economy through transaction. People who productively work in the modern economy of our society either as businessmen, entrepreneurs and employees of the government offices and of large corporations have interactions with the informal economy. In our households we hire people who repair many of the small broken things we own – appliances, furniture, house repair. We buy the goods that they sell. We hire them as household help, etc.

The caimito vendors are reminders that anyone can become merchants as long as marketable produce however small presents the prospect of gain. In the same neighborhood where rich schools and modern communities have a dominant presence – as in the Katipunan Avenue I talk about — there are vendors to be found of every kind. For instance, the sellers of boiled corn on the cob – “Japanese sweet corn” – are a daily sidewalk presence that we see.

Where the traffic slows down in the main city arteries, sun-darkened vendors aggressively push their wares of bottled water, cigarettes, snacks, and all kinds of portable personal gadgets to make a little gain. These ambulant sellers brave very dangerous traffic to earn any small amount of cash to feed their families.

A deeper look into the informal economy. Gustav Ranis (of Yale University, known more in the Philippines as the main author of the so-called Ranis Report during the 1970s) and Frances Stewart (of Oxford University) teamed up to review the studies on the informal economy in a well-known study (in the Cultural Change and Economic Development, 1999). In this study, they also compared the informal economies of both Thailand and the Philippines to provide a time frame with economic growth.

They argue that the informal economy has two major elements. There is one which is a traditional informal economy that acts as an employment sponge for all low productivity activities (such as the ones I described at the beginning of this column). The other informal economy is a dynamic element of the informal sector, adjusting its services to the requirements of the modernizing formal economy.

Ranis and Stewart found that the two sub-sectors of the informal economy behave differently as economic growth proceeds. The traditional, low productivity informal economy often shrinks in the face of successful economic growth. When this happens, low productivity becomes insignificant and poverty is gradually eliminated.

The second part of the informal economy – the one with modernizing components – improves in size as economic success proceeds. The two economists saw in this segment of the informal sector the presence of modernizing self-employed and family based firms whose activities are improved by the expansion of the larger national market. The higher the rate of economic growth becomes and the more competitive is the overall status of the economy, the greater is the possibility that this modern segment of the informal economy will add to the overall economy’s productivity and growth.

In stagnant economies, the size of the informal sector is large in relation to total output. A proliferation of low productivity informal sector activities dominates the informal economy even if there is a small modernizing informal sector. In this case, the informal economy becomes like a sponge for all types of low productivity employments of labor.

Informal economies in Thailand and the Philippines. In their focus on Thailand and the Philippines covering a period from the 1970s until the 1990s, there are examples of two modernizing economies in Southeast Asia. But Thailand grew much faster in the latter period than the Philippines. This contrast in performance enables them to observe the effects on the informal economy of developing economies during the process of growth.

In Thailand, the modernizing small sector of informal activities enlarged their share of total output. On the other hand, the traditional, low productivity informal economy got smaller. Thailand’s economic growth has been much more impressive than the Philippines especially ever since the 1980s.

In the Philippine case, the traditional, low productivity informal sector became larger during the later period when economic growth in the country became challenged by crisis. Even though the modernizing informal sector showed an expansion, the rate of decline of that expansion was quite big. In effect, the modernizing informal sector remained basically sluggish.

The Ranis-Stewart analysis had a good insight into the problem of the informal economy. If they had studied the out-migration of Philippine labor, they might have said further that the sluggish growth of the modern informal sub-sector of the economy was an outcome of the poor domestic economic performance.

The lesson of this note on the informal sector of the economy should not be lost to Philippine policy makers. Only sound economic reform can improve economic conditions at home by design. The direction of reforms should then be, according to the arguments of many discussions in this column, a reform of labor markets and an acceleration of meaningful reforms to make foreign direct investments more welcome in the country.

These measures will dramatically cut down the size of the traditional informal economy. They will encourage greater dynamism among small enterprises that are part of the modernizing segment of the informal economy.

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