What is the Informal Sector?

Felicia Dye

An informal sector refers to economic activities that do not fit the characteristics of traditional sectors. These economic activities are often developed out of necessity, and they are not regulated or taxed. In some instances, they may involve illegal activities, but this is not always the case.

Businessman giving a thumbs-up
Businessman giving a thumbs-up

An informal sector is a concept that can be very difficult to define. Even when individuals attempt to create definitions, these are generally subject to scrutiny and debate. The reason for this is because the term informal sector can apply to a wide range of activities in a variety of settings that are driven by differing motives. One of the safest ways to describe such a portion of an economy, therefore, is to say that it is one that does not fit within the terms and definitions of any of the formal sectors.

In many cases, an informal sector is driven by the lack of opportunity. This is often seen in third world countries where unemployment is high and there are a limited number of jobs. As a means of survival, individuals develop methods to earn income. This often involves creating informal industries. Although these are not subject to regulation, as they become more common, standards may develop.

For example, in some countries theft of easily removable auto parts such as windshield wipers, side-view mirrors, and hubcaps is extremely common. Identifying an opportunity, there are individuals who stand on the street and guard vehicles to prevent this from happening. Although this type of arrangement generally operates on somewhat of a donation basis, standards dictate appropriate payments for these services. Standards may also dictate that higher payments should be provided at night.

Although informal sectors can greatly vary, there is another aspect that each tends to have in common: the lack of taxation. Although some of these sectors may generate a substantial amount of revenue, the nation or local jurisdiction does not receive direct benefits. In some instances, the existence of such sectors may result in economic harm. This often occurs when there is a major informal sector that involves an illegal activity, such as black market foreign exchange.

It is often difficult to gauge the extent of an informal sector because there are no means to measure it. Little, if any, documentation is likely to exist detailing methods and participants. Revenue that is generated tends to be hidden or immediately reinvested in other segments of an economy.

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