WASHINGTON, DC, United States (CMC) — A new study published by the World Bank has found a strikingly large percentage of workers and firms operate outside the line of sight of governments in emerging market and developing economies (EMDEs).

It said that this is a challenge that is likely to hold back the recovery in these economies unless governments adopt a comprehensive set of policies to address the drawbacks of the informal sector.

The Washington-based financial institution said the study, titled “The Long Shadow of Informality: Challenges and Policies”, is its first comprehensive analysis examining the extent of informality and its implications for an economic recovery that supports green, resilient and inclusive development in the long term.

It found that the informal sector accounted for more than 70 per cent of total employment, and nearly one-third of gross domestic product (GDP) in EMDEs.

“That scale diminishes these countries’ ability to mobilise the fiscal resources needed to bolster the economy in a crisis, to conduct effective macroeconomic policies, and to build human capital for long-term development,” the study noted.

It said in economies with widespread informality, government resources to combat deep recessions and to support subsequent recovery are more limited than in other economies

“Government revenues in EMDEs with above-average informality totalled about 20 per cent of GDP — five to 12 percentage points below the level in other EMDEs. Government expenditures also were lower by as much as 10 percentage points of GDP. Similarly, central banks’ ability to support economies is constrained by the underdeveloped financial systems associated with widespread informality.”

World Bank managing director for development policy and partnerships, Mari Pangestu, said informal workers are predominantly women and young people who lack skills.

“Amid the COVID-19 crisis, they are often left behind, with little recourse to social safety nets when they lose their jobs or suffer severe income losses,” said Pangestu, adding “this analysis will help to fill knowledge gaps in an understudied area and get policy makers back on track to tackle informality, which will be critical going forward as we work to achieve green, resilient and inclusive development.”

The World Bank said that high informality undermines policy efforts to slow down the spread of COVID-19 and boost economic growth.

It said limited access to social safety nets has meant that many participants in the informal sector have neither been able to afford to stay at home nor adhere to social distancing requirements. In EMDEs, informal enterprises account for 72 per cent of firms in the services sector.

“High levels of informality generally means weaker development outcomes. Countries with larger informal sectors have lower per-capita incomes, greater poverty, greater income inequality, less developed financial markets, and weaker investment and are farther away from achieving the goals of sustainable development.

“Informality in EMDEs varies widely across regions and countries — as a percentage of GDP, it is highest in sub-Saharan Africa, at 36 per cent. It is lowest in the Middle East and North Africa, at 22 per cent. In South Asia and sub-Saharan Africa, pervasive informality is largely the result of low human capital and large agricultural sectors. In Europe and Central Asia, Latin America and the Caribbean, and the Middle East and North Africa, heavy regulatory and tax burdens and weak institutions have been important factors in driving informality.”

The study shows that informality can be tackled in EMDEs and that in fact, while it remains high, it had been on a declining trend for three decades before the coronavirus pandemic.

Between 1990 and 2018, on average, informality fell by about seven percentage points of GDP to 32 per cent of GDP.

The decline, said the report, partly reflected policy reforms over the past three decades, including EMDE governments implemented policy reforms either to increase the benefits of formal sector participation or to reduce the costs of such activities. These included tax reforms, reforms to increase access to finance, and stronger governance.

The study provides five general recommendations for policymakers in EMDEs:

The first takes a comprehensive approach because informality reflects broad-based underdevelopment and cannot be tackled in isolation, while the second tailor measures to country circumstances because the causes of informality vary widely.

The third, improves access to education, markets, and finance so that informal workers and firms can become sufficiently productive to move to the formal sector with the fourth; improve governance and business climates so the formal sector can flourish.

The World Bank said the fifth recommendation calls for streamlining tax regulation to lower the cost of operating formally and increase the cost of operating informally.