Download Handout 3 - ITCILO eCampus

Handout 3: what does formalisation mean and what policies promote formalisation?
What is formalization?
Formalization must be intended as a transition to the formal economy 1. It implies that it is not
an event, which occurs in a moment, but a process, which involves several phases.
Different views exist about what is meant by formalization and how it can be achieved. Current policy
initiatives around the world show that there is no universal policy framework, but rather a set of
approaches that can be combined and adapted to each specific country context.
Policies should recognize the importance of the informal economy, restricting and regulating it when
necessary, but also seeking to increase the productivity and improve the working conditions of those who
work in it. Formalization will bring benefits not only to both formal and informal employees, but also to
formal and informal entrepreneurs; their institutions and the state as a whole. The process to achieve it
brings also some challenges at individual, institutional and state levels.
The ILO’s perspective is that transitions to formal economy Mainstreaming workers and economic units in
the informal economy into the formal economy;
1.
Preventing formalisation in the formal economy
2.
Addressing decent work deficits in the informal economy in a way to facilitate transitions to
formality.
Formalization processes are those that result in a move towards greater formality of firms and/or jobs
(resulting from strategy (a) above). Formalization processes can take different forms:
Existing economic units moving towards full formality or becoming fully formal.
Existing jobs moving towards full formality or becoming fully formal.
Transitions which result in jobs and economic units being destroyed in the informal economy and
created in the formal economy, resulting in job flows out of the informal economy.
Formalization: benefits and costs for workers, businesses and the state
Workers
Promoting transition for formal economy can lead informal workers out of poverty, powerlessness,
exclusion and vulnerability. This is the way for them not only to obtain labour and social protection, but
also to avoid unsafe and unhealthy work conditions. Through formalization and the connected safety nets,
workers can increase their job security and income stability. Formalization implies that those who
previously were informal workers can have collective representation or voice at national, local or enterprise
levels in policies and plans that affects their livelihoods. This is particularly true for informal workers who
1
This is also the term used in the title of the ILO report “Transitioning from the informal to the formal economy”, Report V(1) for
International Labour Conference, 103rd Session, 2014
are women, child workers, young persons, migrants and older workers. Formalization for them means
leaving conditions of dependence and weakness and starting enjoying their rights.
While a majority of workers in the informal economy are there not by choice but by necessity, some
categories of workers in the informal economy enter it freely for the flexibility it offers; the income it
provides that might in certain circumstances be higher than the one in a formal assignment. While some
informal workers choose to remain informal and still well paid and highly marketable thanks to their skills;
other workers may be unwilling to pay taxes; in particular the willingness to pay social contributions is
related with the trust that people have in the system of social security and pensions. They can think that
their contribution would be much higher than the benefits that they would receive. All reasons which could
induce some informal workers not to wish to formalize their situation. Formalising employment comes as
benefits for a majority of workers in the informal economy, but also involves obligations and costs.
For enterprises and entrepreneurs in the informal economy
Formalization can bring several advantages to informal business. It can brings official recognition of the
property rights and of the right of doing business; which should reduce the risk of entrepreneurs being
harassed by public officials and having to pay bribes. Formalization and recognition could also mean that
those informal entrepreneurs can more easily access capital and credit, investing in their businesses to
obtain economies and higher productivity and sustainability. Achieving a formal status means being able of
establishing a business identity, buying and selling products legally, exporting, and entering into formal
contracts. Access to public infrastructure, including utility connections and other services and public
markets is another benefit for businesses. For formal Employers formalization means creating a better
business environment
characterized by higher productivity growth, efficiency gains, a more skilled
workforce, a safer work environment, greater incentives for innovation and the adoption of new
technology, and the presence of a level playing field for business. Formalization of informal businesses
means eliminating the sometime unfair competition represented by informal business. A formalization
process would mean a fairer distribution of the tax burden.
However, some informal business may not see the immediate advantage of formalization because they
perceive only the costs (higher taxes, compliance costs and social contributions) and not the benefits of this
process. They may see formalization as a bureaucratic burden and setting of new constrictions. Some
businesses might not be attracted by the perspective of growing, because of fear of losing control of a
bigger business.
For Governments
For governments a transitioning economy towards formality could bring benefits by establishing the rule of
law and the equality of rights between citizens, entrepreneurs and workers. Public policies would become
more effective and meaningful, providing citizens with rights. The state could achieve its mission of creating
a level playing field in the market and so fostering a more prosperous development of the country, with
more productive firms and workers. Formalization would bring an increased tax and social contributions
collection and an improved ability of government of investing, providing public services and social security.
A transition towards formalization would make public education more required and demanded (formal
firms are supposedly demanding more educated workers). A more formalized economy would probably
reduce the room for corruption and avoid wrong incentives (incentive to hide, no to formalize employment,
to remain small, to carry capitals abroad, not to specialize, etc.).
Government as a buyer of goods would obtain a wider pool of bidders in public procurement contracts.
Government would better carry out its objective of extending decent work in the society.
Still the public administrations and public powers would face several challenges. In an economy with a
wider formal sector, citizens will probably become more demanding and asking for greater accountability
from politicians and civil servants. A formalization process implies a fairer and more efficient public
administration, with simpler and better rules; law abiding citizens will become less tolerating of
government corruption and will often demand an increase in the quality of public services.
The pension funds should be managed more transparently and in the interest of those who contribute to
them; social protection should be better guaranteed.
Also local governments should take into account the needs of the informal economy.
What policies promote employment and enterprises formalisation?
The need for an integrated policy package to facilitate transition to formality
Around the world policymakers, labour market institutions and social partners are
struggling to address the challenge of the informal economy. In 2002 an ILO Resolution
made clear that single, ad-hoc policies on informality will only have a limited impact.
Experiences in different countries seem to confirm this. Moreover there is not a single
model, which is fit for the situation in every sector, country and moment.
While many countries have good practices to share in different policies, it is only where there has been an
explicit strategy to reduce informality and the development of multiple and coordinated policies that we
have seen a significant decrease at national level of informality. Brazil and Argentina stand out in this
regard. Their success in reducing informality and increasing the rate of formal job creation since the early
2000s illustrate the importance of this coordinated and comprehensive approach.
The ILO’s goal of promoting opportunities for women and men to obtain decent and productive work
applies not just to the formal labour market but to all types of workers and employers. Decent Work has
become an internationally accepted reference point and is recognized not only as an end in itself but as a
key means of achieving global development goals including poverty eradication.
Defining informality/formalisation through the lens of the decent work framework of the ILO, serves
multiple functions. It is for use as a diagnostic tool to analyse and monitor processes and determinants of
informalization/formalization in a given country context; encourage broad based tripartite dialogue for
assessing the impact of policies; and engage in dialogue with other global actors and international
institutions which are increasingly focused on the informal economy and promote their own perspectives.
The framework points to the multiple avenues towards formality by deepening action in each of the policy
areas. It also shows the total impact of these different policies that can create an enabling/disabling
environment towards formality in a given country context (coherence among these policy areas). The
totality of incentives and disincentives that motivate each of the players, governments, employers’, and
workers’ organisations, as well as the workers and entrepreneurs in the informal economy, can be better
evaluated as a result.
The ILO highlights seven policy areas which constitute avenues for transition to formality. An important
caveat to note is that this is not a prescriptive approach. These policy areas have different levels of
importance in different contexts. Similarly the policies adopted by some countries can be a useful guide to
other countries but they must always be adapted to the specificities of different countries. What are the
types of policy areas, which, in an integrated manner, can lead to pathways out of informality?
Macroeconomic policy: which should put employment at its core and not as a residual;
Many analysts believed that informality would disappear with economic development and economic
growth. We can see that informality can persist despite strong and sustained economic growth. Indeed, a
study of twenty developing countries (Heintz and Polin, 2005), clearly illustrated that increasing economic
growth can reduce the rate at which informalization is growing, though it cannot on its own create an
environment where informalization actually Illustration. While growth is a minimum requirement for
reducing informality, if it is based on a policy mix where employment is seen as only a residual element it is
unlikely to produce many jobs or good quality jobs.
Capital intensive growth or growth based on extractive industries rarely generates the numbers of jobs that
are needed to absorb all the job seekers. A policy mix surrounding economic growth which places
employment at the heart of macroeconomic policies on the other hand is much more likely to generate
both more jobs and better quality jobs.
The Regulatory environment: the need of good and well enforced regulation
The regulatory environment stands at the heart of the contested discourses and debates surrounding
informality. Regulation concerns not only labour law, but also health and safety, taxation, accounting rules,
technical standards, consumer rights, bureaucratic procedures, and more. Informal firms and informal
employees are workers and economic units which are ‘de-facto’ or de-jure’ not covered by the law,
however in many cases complying with the law is too complicate or too expensive. Informal firms cannot
make it. The importance of better and more effective regulation is agreed by almost everybody. Complying
with law must become easier and in parallel law enforcement should become more effective. Property
rights of informal entrepreneurs are not sufficiently guaranteed and this puts their activities at risk.
Moreover they cannot use their assets as collateral when asking for credits. Street vendors for example
could considerably improve their situation with a better regulation of the use of public spaces.
An area of importance in affording protection and realizing rights is labour inspection for those in the
informal economy. Enforcement of labour laws is a key problem for many countries. Labour inspectorates
are often under-staffed, under-resourced and have limited capabilities to deal with the informal economy.
As a response many countries are increasing the size of their inspectorates and strengthening the capacity
to deal with informal economy actors. Measures that involve capacity building are more effective than
punitive sanctions for lack of compliance. For example in Chile and Peru inspectorates provide training for
micro and small enterprises (MSEs) to comply with the law, particularly on safety and health issues; firms
are given a period of time to ensure compliance. The Philippines has developed tripartite teams to inspect
MSEs. Brazil has mobile flying squads to reach remote areas.
International labour standards (ILS) may often be misrepresented as being only for the formal economy;
they are in fact a universal set of rights - applicable to all who work, irrespective of where they work. They
can be applied in a flexible manner to national contexts, thereby providing a minimum social floor for all
who work.
Representation and social dialogue: which should be not only for those who are already
represented but also for those who are not yet part of it;
The challenges of organizing in the informal economy are immense, not least because of the mobile,
dispersed and sometimes hidden nature of the informal economy. In many cases, informal workers , e.g.
home-workers, are isolated and do not know each other; in other cases they work on a piece basis or with
short term contracts and they do not want to jeopardize their income taking part to collective initiatives.
Yet representative organizations are key in finding solutions to informality.
Governments have a key role to play in establishing freedom of association and the right to collective
bargaining. Furthermore they can provide the enabling environment for social dialogue to flourish by
setting platforms at various levels. All this should be done having mind that the prevailing conditions in the
informal economy are quite far from those of traditional big size manufacturing establishments or of tenure
employees of the public administration. The diversity of the informal economy points to the diversity of
types of organization required. The relevant forms of organization include but are not limited to: trade
unions, cooperatives, employers’ organizations, associations of self-employed, street associations, and
small business associations among others.
Making room for the representatives of the informal sector will be a challenge not only for the public
authorities, but also for existing trade unions and employer’s organizations, which could find their previous
way of doing business challenged. In some cases they will be able to welcome people coming from the
informal sector in their structures, making them bigger and stronger, in other cases their organization can
have a fruitful dialogue and cooperation with specific organizations created to represent subjects coming
from the informality.
Promoting Equality and Addressing Discrimination: Removing a Major Cause of Informality.
Because informality in many cases is just the only remaining option for those that have been discriminated
in the wider society; by eliminating their discrimination many of them could move to the formal sector or to
formal employment.
Among causes of informality, labour market discrimination plays a key role. Unable to find a job in the
formal labour market or to set up formal business, many young people, poorer women, disabled persons,
migrants, ethnic, indigenous and caste groups are clustered in the informal economy. Women in particular
are often concentrated in the most marginalized segments with fewer assets, skills and income than men.
Policy making requires a gender lens to ensure that the different needs and constraints of women and men
are taken into account. More generally addressing discrimination towards all these categories is a key tool
in order to facilitate the transition towards formality.
Enterprise development: Helping Business to Strengthen, becoming able to Formalize.
Formalization should make business sense, or it will not be a sustainable process. Policy making on
enterprises necessitates an analysis of the diversity of enterprises not only in terms of size but also in terms
of those which are in survival mode and those which have the potential for growth. Some approaches can
be beneficial for all enterprises such as a streamlined, cost-effective and simplified registration process. But
beyond this careful accounting of the different needs and orientations of enterprises is needed to develop
tailored responses to their heterogeneity. Capacity building rather than punitive sanctions has been shown
to be the more effective for micro and smaller enterprises to encourage compliance with regulations. For
larger enterprises disincentives to stay informal may be more appropriate.
A misguided focus only on registration is unlikely to make a dent in rates of informality of enterprises. What
is required is the development of incentives that will encourage a genuine and sustained progression out of
informality.
For this reason it should be accompanied by a strong effort to make many units, now operating informally,
stronger and fitter to operate in the market. This can be facilitated also with the provision of information
and market support e.g. through business support centres and educational TV programs, with the provision
of skills training and with a simplified access to land, technology and credit. Appropriate pedagogical
techniques and delivery mechanisms tailored to the informal economy can, when combined with business
training, access to credit and other productive resources, be an entry point into the mainstream economy.
Social protection, which contributes to decent work, fosters productivity, strengthen the rule of
law and fosters formalization.
Informal economy actors have a high exposure to health and economic risks, yet are amongst the least
protected. National social protection floors should comprise at least the following four social security
guarantees:
1. Access to essential health care, including maternity care;
2. Basic income security for children, providing access to nutrition, education, care and any other
necessary goods and services;
3. Basic income security for persons in active age who are unable to earn sufficient income, in
particular in cases of sickness, unemployment, maternity and disability;
4. Basic income security for older persons.
While social protection instruments may appear costly, even low income countries have been able to reach
out to those in the informal economy using a combination of different instruments. They are proving to be
invaluable in addressing multiple dimensions of poverty and informality.
Measures that improve access to basic health care are particularly important since that is often the first line
of protection that informal economy actors look for. Countries have also put in conditional cash transfer
schemes, extended social insurance, and developed a range of strategies targeting informal economy
actors among other measures.
Maternity also poses great economic and health risks for informal economy women. Childcare and
dependent care is often perceived as a private responsibility by policy makers and often a low priority for
resource allocation. Yet a woman’s access to formal and decent work is often entirely contingent on the
extent of her family responsibilities. Lack of childcare is often a symptom and cause of unequal gender
relations, with girls often taking over dependent care responsibilities at the expense of their schooling.
Local economic development processes are an important tool to foster the formalization process.
Every policy becomes effective only when it has effects at local level. Local development strategies can play
an important role to support transitions to formality. There are a range of strategies which local authorities
can put in place to foster the economic regeneration of their communities.
Local authorities often play a key role in these fields: 1) Urban planning, 2) Management of local roads,
open spaces and street markets, should take into account the existence of street vendors and their need to
operate in the open space; 3) Public transport should be managed taking into account the presence of an
informal transport sector 4) Labour intensive infrastructural development with multiplier effects at the
local level may be initiated to create employment to develop assets for communities; 5) In some countries
local authorities have influence on local land registries; in these case they can play a positive role in the
registration of the property rights of informal entrepreneurs; 6) In some cases local authorities control the
access to such utilities as water, electric power and gas, then they can play a key role in facilitating the
availability of these services by informal entrepreneurs, 7) In some cases local government control local
banks, in other cases they can put resources for credit guarantee schemes. In both cases an important role
through the extension of credit.