Developing countries have large, complex informal sectors. Informality provides workers and firms with flexibility at the cost of security, often leaving individuals worse off in the long-term. What have we learned from research on informality, and how can we use it to inform policy?
Issue 2 of our VoxDevLit on Informality is out now! In this episode of VoxDevTalks, Gabriel Ulyssea and Nina Harari explore the complexities of the informal sector. Drawing on their comprehensive VoxDevLit, the episode sheds light on the causes, characteristics, and consequences of informality in developing countries.
Informality spans workers and firms, playing a dominant role in many economies.
“It’s pretty massive across countries… between 20% in the low informality countries, up to 80-90% of the labour force in some sub-Saharan African countries.” Ulyssea
Informal housing also represents a significant global challenge.
“According to UN estimates, about 1.1 billion people, which is roughly 25% of the world’s urban population, live in informal settlements or slums.” Harari
What does it mean to be informal?
Informality means existing outside of the protections and recognition of formal institutions. For workers, this translates to limited rights and no access to standard employment benefits.
“You’re not covered by unemployment insurance... You’re not covered by the minimum wage and legislation… You’re not eligible for pensions when you retire.” Ulyssea
For firms, informality is multifaceted. Some are completely unregistered—what Ulyssea calls the ‘extensive margin’—while others are formally registered but hire workers off the books.
Harari adds that for housing, the definition is equally blurred.
“There isn’t a clear-cut definition of what counts as a slum or informal housing.”
Informality and the labour market: Flexibility versus security
From a worker’s perspective, informality can be a choice, driven by flexibility, or a trap with limited upward mobility.
“There are some workers that actually seem to be trapped in informality… They might be in and out to non-employment, but back to the informal sector.” Ulyssea
Formal jobs provide more security, while informal work offers flexibility. Although informal workers generally earn less, gross wages are often similar within the same firm —and with no tax deductions, their take-home pay may actually be higher.
Firms and informality: Size, incentives, and constraints
Firm informality, like labour informality, is complex. Smaller, less productive firms are more likely to remain informal, often due to cost-benefit calculations.
“The benefits of being formal are very low in developing countries for small firms.” Ulyssea
Interestingly, informal and formal firms are deeply intertwined.
“40% of informal workers are in formal firms… Policies targeted at informal firms will not get to these informal workers working for formal firms.” Ulyssea
Formalisation policies often disappoint. Lowering registration costs typically has a ‘big zero’ effect. Even tax reductions have limited impact.
“How much formalisation you induce by reducing taxes does not compensate the losses you have by reducing taxes on already paying firms.” Ulyssea
Housing informality and policy challenges
Turning to housing, Harari outlines the difficulties in defining, measuring, and addressing informal settlements.
“Informal settlements often lack the basic infrastructure that many of us would take for granted, like piped water, sewage, electricity, road access.” Harari
Several policy tools are discussed, each with trade-offs. Titling can incentivise investment but is difficult to do at scale. Relocation into public housing is often disruptive and only works when residents maintain proximity to job markets and social networks.
Slum upgrading—improving existing infrastructure in place—is cheaper and less disruptive.
“You upgrade on site, and the hope is that the public investments will spur private investments and also deliver immediate improvements in the living conditions.” Harari
However, this may prolong the life of slums in high-value areas, raising equity versus efficiency debates. Sites and Services programmes, which prepare plots before people settle, can support orderly growth but often fail to reach the poorest due to high costs.
Informality, policy, and politics
The episode ends on a reflective note, emphasising that informality is deeply connected with other market failures—housing, credit, transport—and shaped by political dynamics.
“We already have the tools... to enforce the laws and regulations we have in a more effective way to make the informal sector smaller… there’s a very high social cost associated to that.” Ulyssea
Short-term political cycles complicate long-term reform strategies.
“Housing informality is intertwined with informality in all these other key markets… there isn’t a silver bullet.” Harari
Key takeaways and future research on informality
Informality is not just about exclusion or lack of regulation—it is also about choice, flexibility, survival strategies, and deeply rooted institutional and political dynamics.
“We need a better understanding of how low-income residents in developing countries’ cities are making all these joint decisions—where to live, where to work, how to commute—facing market failures across all these different margins at the same time.” Harari
And for researchers or policymakers just beginning to engage with these issues, Ulyssea offers a parting thought.
“These are the questions that make a lot of the development economics debate in these countries.” Ulyssea