The informal economy - that is, those individuals and firms not fully complying with state registration and taxation requirements - occupies as much as 80% of developing country markets. The trade that exists within an informal economy is vast and essential to the well-being of that country's economy. But a vexing question that has avoided resolution thus far is how that domestic trade is affected by changes in international trade. Until recently, developing countries had little role to play in global trade as most trade moved between developed country markets. Today, developing countries play a significant role in trade and are likely to continue increasing their share of the global marketplace.

The International Labour Organisation has been discussing the importance of the informal economy in domestic trade since 1972. The World Trade Organisation has been harking on the importance of bringing developing countries into the world trading regime since its inception (and really even before that with the formation of UNCTAD in 1964). This year, these two organisations joined forces to explore the linkage between expanding international trade and informal economies. The report, "Globalization and Informal Jobs in Developing Countries," is a comprehensive examination of the inverse relationship of trade expansion and informal economy growth and, while not intending to put the issue to rest, it does a nice job of providing useful data on various areas of impact. It does not focus on informal firms directly (my particular area of interest) but rather on the labor market. The report echoes the assertions of authors that have broached this topic previously by concluding that more trade is usually associated with higher rates of informality, either because domestic workers are replaced by technology or foreign workers, or because foreign investments often yield short-term gains that create little lasting growth in the formal economy. Interestingly, the report highlights the vicious circle of informality and trade - high rates of informality lead to less productive investments, leading to lower wages and continued growth of informality.

The report concludes with a recommendation to continue the current trend toward increased formalization. They note the distinction between formalizing firms and workers, explaining that firms should be encouraged to formalize through reductions in the red tape of small business registration and taxation systems, whereas workers should be formalized by providing opportunities to work in more productive environments (investing in infrastructure, for instance) while at the same time providing basic social protections for those workers as this is a long-term process.

No doubt a positive recommendation following a less than positive report, there is reason to doubt the viability of these recommendations. Incentivizing firms through tax breaks and faster registration processes does nothing to address the root cause of their informality. Economic incentives are insufficient to address the needs of informal firms in most developing countries today. Workers that benefit from the informal economy job opportunities may hesitate to leave behind that income for an uncertain future in the formal economy. The history of volatile labor markets encourages an atmosphere of distrust that the state, or the private sector, can provide stability in the formal labor market, making the informal economy, with its flexibility and availability in times of crisis, a reasonable alternative.

The report is available here:

http://www.ilo.org/global/What_we_do/Publications/Newreleases/lang--en/docName--WCMS_115087/index.htm

KJF