Rule of Law and the Informal Economy

If you have an interest in rule of law, trade liberalization, and the informal economy, you may find this dissertation interesting:

DOCTORAL DISSERTATION: Beyond the Invisible: Formalization Policies and the Rule of Law in the Informal Economy

ABSTRACT

Trade liberalization in Latin America has substantially altered business opportunities and economic development in the region. As barriers to competing inputs have come down and foreign investment in the region has gone up, small, domestic firms have struggled to stay afloat. Many small businesses have survived by skirting the legal requirements to operate a business, including registration and taxation, thereby bringing their operating costs just low enough to earn a profit. As trade liberalization continues to reduce barriers to foreign competition, and domestic firms face increasing pressure to compete, these “informal” firms have come under increasing pressure to legitimize or cease operations. With strong pressure from the tax-paying business community, international organizations, and foreign industry, many countries have increasingly begun formalization programs that target informality as a reason for slow growth in the face of open trade.

In this thesis, I pose a straightforward question—is formalization good for economic development? This question opens the door to an evaluation of the underlying cause of informality, the basis for the push for formalization, and an assessment of the likely result of such a process.

Formalization attempts to remedy the problems of low productivity and aversion to compliance with the law through economic incentives, such as tax discounts and streamlined business procedures that are intended to help firms make their way into the formal marketplace. However, in many developing countries, the informal economy is an economic consequence of trade pressures, and a legal consequence of a failed social contract between the state and its small business community.

In its current iteration, the formalization process is coupling the tools used to improve business practices and procedures with the legalization process for millions of existing informal firms. By doing so, the state is ignoring the dual legal and economic framework within which informal firms operate. Improvements in business processes are good for business and can help existing and intending formal firms succeed. But these are much less likely to overcome the deep-rooted failure of the state to address the needs of the bulk of the citizenry.

I argue that an effective formalization process must 1) address the terms of the social contract between the state and its informal economy, and; 2) make improvements in social programs to protect the health, safety and prosperity of existing informal firm operators. It is my contention that informal firms have largely rejected the state’s rule of law contract because the firms are unwilling to cede their freedom to operate an informal business in exchange for state protection of property or rights that they rarely possess. As such, in order to not only reduce the growth of the informal economy, but also to improve the rule of law, the state must take aggressive steps to reform their arrangement with the informal economy by building dynamic linkages between formal and informal legal and economic frameworks. An immediate step that states should take, I argue, is to implement programs that remove some hazards of operating an informal business by enforcing restrictions on the use of certain public space, providing safety equipment to street-based firms, and investing in improvements in the design of public space.

This modified formalization approach is not intended to rapidly eliminate the informal economy. Rather, it is aimed at improving the economic development of the state through an enabling, rather than a punitive approach. This modified approach will increase the value of the social contract and rule of law to informal firms; illuminate a pathway to voluntary legalization; protect individuals operating informal firms, and; improve access to education, training, and social services for all small firms. Capitalizing on the contributions made by the informal economy to a state’s economic development may help to turn a destructive process into a growth opportunity.


[For further information about this dissertation, please email me.]

KJF

Law and Society Meeting

I will part of an excellent panel at the Law and Society annual meeting in Chicago on May 29, coordinated by Amanda Perry-Kessaris (University of London). The panel description is below:

CRN24 Rule of Law, State Building, and Transition--Roundtable--Success in Law and Development: Evaluating the Conventional Wisdom of Using Evidence from the Field 3403

Law and development works involves Assessing existing rights and duties, Building capacity, Contesting existing and future rights and duties, Delegating the implementation of projects and Evaluating outcomes. This round table is made up of participants who have conducted extensive field work in developing and transitional economies. Drawing on their field work, each participant will give a short presentation about the extent to which a specific legal reform program has achieved its objectives. Thereafter, there will be a round table discussion covering a broader discussion on the role of legal reforms and what is working and what is not. At this point the audience will be invited to participate in the discussion.

I hope that you can attend.

KJF