Exhaustiveness, part 4 Informal Economy 1

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1 Exhaustiveness, part 4 Informal Economy 1 Introduction This paper continues the series dedicated to extending the contents of the Handbook Essential SNA: Building the Basics 2. One of the main themes in this series has been GDP compilation since GDP (Gross Domestic Product) is the most important single indicator measuring economic activity in a country. Earlier in this series we reviewed the three main approaches to GDP compilation the production approach, the expenditure approach and the income approach. Since these separate approaches all aim to measure the same GDP, an important goal for national accountants is to minimize the discrepancies between these different compilations. A closely related goal is to make the estimates of GDP exhaustive. We therefore set out to provide some general background to the role of exhaustiveness in GDP compilation. Non-exhaustiveness may be caused by defective imputations, by missing units, by missing activities or by under-reported values. We introduced the Eurostat tabular approach to exhaustiveness which was designed to identify potential sources of non-exhaustiveness in the national accounts 3. In this paper we want to shift perspective from the overall exhaustiveness framework as provided by the Eurostat tabular approach to the particular groupings of non-observed economic activities as provided by the OECD Manual on the Non-observed economy. The concept of the Non-observed economy (NOE) was briefly introduced in a previous paper, where we distinguished the following NOE categories 4 : 1. Illegal activities 2. Underground activities 3. Production of households for own final use 4. Non-observed informal activities In this paper we will provide some background on the last category, non-observed informal activities, making up part of what is known as the informal economy 5. Informal sector: concepts and definitions Our focus thus far has been on the NOE as a framework to categorize and measure activities that fall outside the regular statistical enquiries, such as illegal and underground activities, in order to ensure 1 This paper was initiated and financed by EUROSTAT through the Project Essential SNA: Building the Basics, implemented by DevStat Servicios de Consultoría Estadística in consortium with ICON Institute, for which information can be found at the following link: 2 Henceforth called the Handbook ; this paper is based on the second (2012) edition; it can be found at the following link: Further details on how statistics producers, such as national or international statistical institutes, may address implementation issues related to the informal economy can be found at Building_the_System_of_National_Accounts_-_informal_sector 3 See the papers: Exhaustiveness, part 1 Main issues 4 Ibid. 5 The other categories were treated in: Exhaustiveness, part 2 Illegal Economy; Exhaustiveness, part 3 Underground Economy. 1

2 that GDP estimates are exhaustive. As SNA makes clear there is a second approach to exhaustiveness which aims to measure that part of the economy that reflects the efforts of people without formal jobs to engage in some form of monetary economic activity (SNA 25.3). Such activities belong to what is known as the informal sector. Although this second approach can to a large extent be accommodated within the NOE framework, it is usually carried out quite independently of exhaustiveness or NOE considerations and may to some extent be incorporated within the regular program of statistical observation. Informal units such as street traders or small repair shops may or may not be observed through statistical enquiries, and this may vary in different countries. Especially in developing countries the informal sector may constitute an important part of the economy, and it is therefore important to put in place measurement and compilation procedures to ensure that at least a significant part of it is incorporated properly in the GDP estimates. To the extent that errors and omissions negatively affect the quality of these procedures adjustments for non-observation may be needed as well. What does informality mean 6? Rather than focusing on informal activities as is usually done in national accounts, let us start with informal employment. An international trade union symposium organized by the ILO in categorized informal sector workers into three broad categories: 1. Owner-employers of micro-enterprises, who employ a few paid workers; 2. Own-account workers, who own and operate one-person businesses, who work alone or with the help of unpaid workers, often family members and apprentices; 3. Dependent workers, paid or unpaid. These include wage workers in micro-enterprises, unpaid family workers, apprentices, contract labour, home-workers and paid domestic workers. Looking not at employment but at enterprises, we can distinguish between two categories of informal economy enterprises: 1. Family enterprises ( family associations ) comprised of independent and own-account workers, family workers, apprentices and workers, and with no permanent employees; 2. Micro-enterprises comprised of units with less than a certain threshold, e.g. 5 to 10 employees (or jobs), and which are not registered as enterprises. In order to come to a statistical definition of the informal sector a good starting point is the fifteenth International Conference of Labour Statisticians (15th ICLS, 1993) which achieved a breakthrough in making an operational definition of the informal sector for statistical purposes 8. To do so the informal sector had to be defined in terms of characteristics of the production units (enterprises) in which the activities take place (enterprise approach), rather than in terms of the characteristics of the persons involved or of their jobs (labour approach). Let s introduce some terminology. An enterprise covers not only producing units that employ hired labour, but also those that are owned and operated by single individuals working on own-account as self-employed persons, either alone or with the help of unpaid family members. The production 6 See Box VI.2 of the Handbook for some examples of informal sector activities. 7 Trade Unions and the Informal Sector: Towards a Comprehensive Strategy. ILO Background Paper for the International Symposium on Trade Unions and the Informal Sector, October th International Conference of Labour Statisticians: Highlights of the Conference and text of the three resolutions adopted. Bulletin of Labour Statistics , IXXXIV. ILO, Geneva. 2

3 activities may be undertaken inside or outside the business owner s home; they may be carried out in identifiable premises or without fixed location. Accordingly, independent street vendors, taxi drivers, home-based workers, etc., are all considered to be enterprises. Production units of the informal sector have the characteristic features of unincorporated enterprises in the household sector. The fixed and other assets used do not belong to the production units as such but to their owners. The units cannot engage in transactions or enter into contracts with other units, nor incur liabilities, on their own behalf. The owners have to raise the necessary finance at their own risk and are personally liable, without limit, for any debts or obligations incurred in the production process. Expenditure for production is often indistinguishable from household expenditure. Similarly, capital goods such as buildings or vehicles may be used indistinguishably for business and household purposes. In contrast to corporations and quasi-corporations, a household unincorporated enterprise is a producing unit that is not constituted as a separate legal entity independently of the household members who own it. Informal sector enterprises are defined as a subset of household unincorporated enterprises. The 15th ICLS operationalized the informal sector for statistical purposes by taking the informal sector as those household unincorporated enterprises with market production that are either informal own account enterprises or enterprises of informal employers 9. Informal own-account enterprises are household enterprises owned and operated by own-account workers, either alone or in partnership with members of the same or other households, which may employ contributing family workers and employees on an occasional basis, but do not employ employees on a continuous basis. The 15th ICLS did not include any size criterion in the definition of informal own-account enterprises, since such a criterion was considered superfluous, as by their very nature virtually all own-account enterprises are small. Enterprises of informal employers are household enterprises owned and operated by employers, either alone or in partnership with members of the same or other households, which employ one or more employees on a continuous basis. It was recommended that enterprises of informal employers be defined in terms of one or more of the following three criteria: small size of the enterprise in terms of employment; non-registration of the enterprise (defined as for informal own-account enterprises); non-registration of its employees We will sometimes shorten enterprises of informal employers to employers and instead of own account enterprises use the term own-account workers. Both employers and own-account workers are in the household sector and own and operate unincorporated economic units without a complete set of accounts. Given that the measurement of output should be consistent with the SNA production boundary, household unincorporated enterprises that are exclusively engaged in the production of goods or 9 See Box VI.2 of the Handbook for the classification of informal sector units in the institutional sector classification of SNA. For Household Unincorporated Enterprises with some Market production (HUEM), see Compilation of output and gross value added from sample survey data on Household Unincorporated Enterprises with At Least Some Market Production (HUEMs), Working Paper No. 2, Interregional Cooperation on the Measurement of Informal Sector and Informal Employment ( 3

4 services for own final consumption or own fixed capital formation (e.g. construction of own houses) are excluded from the informal sector, with the possible exception of households employing paid domestic workers. In principle, household unincorporated enterprises engaged in agricultural and related activities can be included in the informal sector, if they meet the criteria of the definition. For practical data collection reasons, however, the 15th ICLS recommended excluding agricultural and related activities from the scope of informal sector surveys and measuring them separately. The 15th ICLS recognized that activities excluded from the scope of the informal sector were not necessarily formal. Examples are the household non-market production of goods, small-scale agriculture, paid domestic services, and activities presently falling outside the SNA production boundary, such as domestic or personal services provided by unpaid household members and volunteer services rendered to the community. It was recommended that such activities should be identified as belonging to a separate category outside the formal/informal sector distinction. One of the core issues discussed at the 15th ICLS is whether or not there is an intrinsic relation between non-registration and the notion of informality. Both viewpoints have their defenders and there was no agreement at the 15th ICLS as to which of the two approaches is better. Thus, the definition finally adopted by the 15th ICLS incorporated both approaches in the sense that it allows non-registration and/or employment size to be used as criteria to distinguish informal sector enterprises from other household unincorporated enterprises. Criteria for the informal sector: the Delhi Group In order to measure and compile national accounts aggregates for the informal sector such as output and value added, it is important to have precise criteria to delineate informal from formal units. The 15th ICLS definition of the informal sector is an umbrella definition, as the scope and coverage depends on national circumstances. All economic units operated by own-account workers can be part of the informal sector or only those which are not registered. Among employers, only those economic units not registered, and/or those which employ less than 5 permanent employees can be part of the informal sector. To build upon the 15th ICLS resolution, the Delhi Group on informal sector statistics was subsequently instituted to identify a subset of the informal sector that could be defined uniformly and for which countries could make internationally comparable data available 10. After in-depth deliberations, the Delhi Group concluded that the national definitions of the informal sector could not be fully harmonized at present as the informal sector manifested itself in different ways in different countries. It recommended that all countries should use the criteria of legal organization (unincorporated enterprises), of type of accounts (no complete set of accounts) and of product destination (at least some market output). Specification of the employment size cut-off for the informal sector was left to the country s discretion. For international reporting, however, countries should provide figures separately for enterprises with less than five employees. In the case of multiple establishment enterprises, the size limit should apply to the largest establishment 11. Subsequent work of the Delhi Group examined many studies on national practices in the collection of data on the informal sector. This eventually led to the publication of a manual on the informal sector See also Box VI.3 of the Handbook for Delhi Group recommendations. 4

5 and informal employment by the ILO 12. This manual is intended as a technical guide for national statistical offices and other producers of statistics on the informal sector and informal employment. It presents the current international standards on employment in the informal sector that were adopted by the 15th ICLS in 1993, as well as the guidelines on informal employment adopted by the 17th ICLS in 2003 (see next section). It also provides practical guidance on implementing the standards, by presenting alternative measurement methodologies along with examples based on national experience, and includes guidelines for the dissemination of statistics on the informal sector and informal employment. Beyond the 15th ICLS: informal employment The 2002 International Labour Conference (ILC) Resolution concerning decent work and the informal economy 13 considered that the term informal economy was preferable to the term informal sector since the latter term is in fact not a sector in the sense of a specific industry group or economic activity. The term informal economy has come to be widely used instead to encompass the workers and enterprises in both rural and urban areas operating informally. They include ownaccount workers in survival-type activities such as street vendors, paid domestic workers employed by households, home workers and workers in sweatshops who are disguised wage workers in production chains, and the self-employed in micro-enterprises operating on their own or with contributing family workers or employees. The informal economy consists of the totality of informal jobs. Employees are considered to have informal jobs if their employment relationship is, in law or in practice, not subject to national labour legislation, income taxation, social protection or entitlement to certain employment benefits. While in developed countries informal activities are characterized by their concealment, in developing countries a large proportion of informal activities are highly visible (street vendors, shoe cleaners, car washers, food stall operators). Since the 2002 ILC, labour statisticians have agreed on the value of supplementing statistics on employment in the informal sector with statistics on informal employment. International statistical guidelines on the definition of informal employment were drawn up by the 17th International Conference of Labour Statisticians (17th ICLS) in Informal employment is a broader, job-based concept that includes both informal sector jobs and those outside the informal sector. Informal employment, as defined by the th ICLS, refers to jobs or employment, rather than economic units. It is comprised by informal sector employment and informal employment in either formal or informal enterprises. Depending on the available information on these jobs, informal jobs can be imputed to various institutional sectors. For example, in the household sector, employers may not declare all of their employees. In non-financial corporations and financial corporations unprotected employees may be hired directly through precarious contracts or indirectly through sub-contracting arrangements. Finally, the government and the non-profit sector, may also employ informal labour. The measurement of informal employment excluding informal sector employment also provides a basis for an estimate of underground production by industries in institutional sectors other than the 12 Measuring informality: A statistical manual on the informal sector and informal employment, ILO

6 household sector, thus providing a link to the measurement of the underground economy as explored in the previous paper 14. The importance of the informal economy Studies have shown that, in many developing countries, the informal sector could account for over 50% of non-agricultural employment and nearly 30% of non-agricultural GDP. Even in many countries with the economy in transition, the size of the informal sector is estimated to be around 10% 15. The consequences of informal activities for a country are wide-ranging and will affect policy formulation in many ways. Some examples of issues related to the informal sector are 16 : Lack of social protection and insurance. Informal workers are subject to high levels of insecurity and vulnerability as they often lack access to social and employment protection and insurance systems. Programmes that seek to improve the economic well-being of the poor need to be backed by statistics on informal employment. Not only are many of the working poor employed in informal employment but informal employment can be the most effective means for them to rise out of poverty. Growth and productivity. The informal sector can influence economic performance through several channels, although the net effect is unclear. On the one hand production in the informal sector often generates inefficiencies, e.g. because of their small size or because they use backward production technologies. Also, they may find it difficult to access finance through traditional channels leading to under-investment in physical capital. On the other hand the informal sector may be beneficial for growth since it may allow small entrepreneurial firms which may grow to be successful formal sector firms to avoid paying the costs of being formal (e.g. taxes, social security contributions, minimum wages). Also, incomes generated in the informal sector are spent in the formal sector and provide a boost for the formal economy. Economic development. Small and micro-enterprises are a focus of attention for policymakers because they are seen as having great potential for job creation and income generation. Statistics on the characteristics of the economic units that comprise the informal sector are needed for designing and implementing programmes aimed at increasing the potential of informal enterprises. Labour regulations. Statistics on the number and characteristics of workers in informal employment may be useful both for advocating and for developing labour standards. They may help to focus public attention on issues of social concern, such as child labour and racial or gender-based discrimination. Erosion of tax revenues. A high degree of informality implies that a given level of public spending will require higher tax rates on the income and profits of formal businesses. 14 See table VI.1 of the Handbook on the conceptual framework for the informal economy as proposed by the 17th ICLS. 15 Data given in the documentation of the project Interregional Cooperation on the Measurement of Informal Sector and Informal Employment ( 16 Based on the ILO Manual on measuring informality and on: Andrews, D., A. Caldera Sánchez and Å. Johansson (2011), Towards a Better Understanding of the Informal Economy, OECD Economics Department Working Papers, No. 873, OECD Publishing. 6

7 Measuring informality Surveys A number of different survey approaches have been used in countries. First, existing surveys of the economically active population and similar household surveys provide a useful and economical means of collecting data on employment in the informal sector in terms of the number and characteristics of the persons concerned and the conditions of their employment and work. For this purpose, questions pertaining to the definition of the informal sector can be incorporated into the survey questionnaire and asked in respect of all persons employed during the reference period of the survey, irrespective of their status in employment. Second, establishment censuses (and consecutive sample surveys) can be used but are now taken as the old-fashioned approach for surveying the informal sector. They actually fail to capture the diversity of informal sector activities as they do not cover the households. In fact, it is common practice to use the presence or absence of an enterprise (establishment) in the business register to define the practical boundary between formal and informal. Notwithstanding this limitation, enterprise censuses and surveys remain a useful and efficient method of data collection on the upper segment of the informal sector (i.e., identifiable establishments). In general, however, there is now a clear preference for so called mixed household / enterprise surveys. The basic principle of mixed household and enterprise survey is to construct a sampling frame of informal sector enterprises through a household survey operation, prior to the informal sector survey itself. The household survey component, if appropriately designed, makes it possible to identify informal sector enterprises rather than establishments, and to cover virtually all informal sector units irrespective of size, kind of activity, and type of workplace Survey As an application of a mixed household and enterprise survey, the Survey is an innovative tool for monitoring the informal sector and poverty 17. It has a flexible architecture, its costs are low, and the concept has proved its value in Africa, Asia and Latin America. It explicitly addresses some of the main limitations of the classical approach: the problem of the "visibility" of informal establishments, the risk of double counting units, the question how to capture activities not confined to a particular location and the difficulties of establishing and maintaining up-to-date registers of informal establishments. The type mixed survey approach is based on a system of surveys which combines households and informal producers. The system can be broken down into three phases. The first phase is a survey of households, determining the supply of labour, the structure of employment (participation rate, unemployment rate, pay, professional mobility) and working conditions (premises, working hours). It also allows for the identification of the heads of Informal Production Units (IPU), who are the source of informal activities and who will be interviewed during the next stage. IPUs need to satisfy the following criteria: 1. they will be an employer or a person working for their own account; 2. they will be engaged in an activity not registered in the register of establishments; 3. they will not 17 ILO Manual on Measuring informality, The Mixed Survey has been conducted in a number of developing countries with support from the European Community, see Measuring The Non-Observed Economy (NOE) : The Mixed Survey: Main Principles, Rémi Bardon ( Collection/Instruments/Measuring-Informal-Economy Mixed-Survey.pdf) 7

8 keep formal written accounts. The second phase uses a survey of those involved in the informal sector to determine the components of the IPUs economic activities. It is concerned in particular with investigating their behavior in matters of employment, prices, production, investment and competition. It also offers an analysis of how the informal sector fits into the national economy (study of inputs, outputs and customer structure). Finally, it facilitates the compilation of national accounts, supplying information for estimating the informal sector (production account, distribution account, capital account). In the third phase households consumption is analyzed, enabling the quantification of the demand generated by the informal sector. This part is basically an income and expenditure survey designed not only to determine the level and structure of household consumption but also to estimate the share of the informal sector in household consumption (and in household fixed capital formation). It uses accounts diaries (for daily expenses on food items) and retrospective modules for all others consumption categories (health, education, clothing, etc.), based on a reference period of six months to two years depending on the frequency of purchase. Labour indicators An important drawback of using survey data to measure the informal economy is that the sample is not necessarily stratified along the dimensions that are potentially relevant for informality (e.g. sectoral breakdown). Like all surveys, these measures may also be sensitive to the way the survey is constructed. Firms and individuals may also be inclined to under-report the true extent of informal activity, to the extent they are uncomfortable admitting to engaging in an activity that contradicts social norms or are concerned about the potential legal consequences if the information is made public. Various indicators based on employment data can be used as proxies for the size of the informal sector. The share of self-employment in the labour force (or in total employment) is commonly used as such a proxy. It is often argued that the self-employed are likely to engage in informal activities given the nature of their business operations. While data on self-employment are widely available, a main drawback of using the share of self-employed is that it is likely to pick up a host of formal activities in addition to informal activities. Another proxy for informality is the number of multiple job-holders. Disguising secondary income may be relatively easy, particularly if employment is irregular or seasonal, and could prove difficult for enforcement agencies to detect. The size of the informal economy may also be gauged by the share of illegal immigrants in the workforce, given that this group is likely to have a higher propensity for undeclared work by virtue of their legal status. Ralf Hussmanns from ILO has developed a module for the informal sector that can be integrated within a traditional labour force survey 18. This approach has been adopted by the Delhi Group, and has been tested in a number of countries. Usually, the following information on persons employed in the informal sector/informal employment is already available from a labour force survey: 18 R. Hussmanns, Measuring the Informal Economy: From employment in the informal sector to informal employment. (ILO Working Paper No. 53, December 2004) 8

9 Socio-demographic characteristics: sex, age, marital status, relationship to the reference person of the household, level of education, place of usual residence, urban vs. rural area, etc. Household/family characteristics: number of household/family members, household/family type, etc. Hours of work and earnings Branch of economic activity (industry), occupation and status in employment Other characteristics of the job: full-time vs. part-time work, job permanency (permanent, temporary, seasonal, occasional, etc. job) The information obtained from the survey question(s) on branch of economic activity makes it possible to exclude persons engaged in agriculture, hunting, forestry and fishing activities, domestic employees employed by households, as well as persons exclusively engaged in the production of goods for own final use. It should also be noted that if properly designed, questions on the form of registration of the enterprise cover not only the criterion of non-registration, but at the same time also the criteria of kind of ownership, legal organization and type of accounts which are used to identify private unincorporated enterprises (excluding quasi-corporations). Thus, only few questions need to be added to a labour force survey questionnaire in order to identify persons employed in the informal sector. Information needed for national accounts As SNA explains the informal sector is not strictly a sector in the SNA sense and so the figures for it cannot be presented in terms of the full sequence of accounts. The information relating to activities undertaken informally extends only as far as the production and generation of income account. It is usually not possible to go further in the sequence of accounts because of the impossibility of identifying which other income flows, consumption and capital formation relate only to the activity in question rather than to the household to which they belong as a full institutional unit. However, SNA recommends that where possible two supplementary tables should be prepared, one covering production and the generation of income and one covering employment (SNA 25.75). SNA proposes that the following type of information be provided for the production table: Production o of which for own use Intermediate consumption Value added Compensation of employees (for unincorporated enterprises with employees only) Gross mixed income Consumption of fixed capital Net mixed income. Further information may also be useful if available. For example, a breakdown of production by type of activity and, possibly, the proportion of the total production in the industry produced by informal enterprises. 9

10 For the employment table SNA proposes that information on the number of jobs should be presented showing: Employment in the informal sector o Formal jobs o Informal jobs Informal employment outside the informal sector o In the formal sector o In other household unincorporated enterprises. If possible, information on the hours worked in each of these categories would be useful. An example of a recent measurement strategy A recent example of the use of surveys to collect data on the informal sector and to assess the contribution to GDP is the project Interregional Cooperation on the Measurement of Informal Sector and Informal Employment by ESCAP (United Nations Economic and Social Commission for Asia and the Pacific) 19. The objective of this project was to improve the availability and the analyses of data on the informal sector including employment and contribution to the GDP and informal employment in developing countries and countries with the economy in transition. The project recognized the importance of data on the informal sector and informal employment, and their effective use in promoting evidence-based socioeconomic policies and achieving the Millennium Development Goals and Targets. All participating countries obtained data on informal employment and the informal sector through a combination of survey instruments that accommodated their specific needs and planned national survey activities during the project period. The main approach centered around an integrated labour force survey (LFS), comprising three linked surveys conducted in three stages, an approach which is equivalent to the Mixed Survey mentioned earlier: Stage 1 A Revised LFS that includes the introduction of the ILO module on the informal sector, to measure informal employment and identify informal enterprises. Stage 2 An Enterprise Survey of the informal enterprises identified in the Stage 1 Revised LFS, to collect information on working conditions and productive performance of the informal enterprises. Stage 3 A Household Income and Expenditure Survey (HIES) among a sub-sample of the Stage 1 sample households to collect data on household income and consumptions related to the informal sector. Alternatively, a country that planned to conduct a national HIES around the time of the Revised LFS could consider replacing the Stage 3 Survey by utilizing the planned national HIES with proper identification of informal enterprises and sources of income and consumption, and proper follow-up questions. A country could also consider replacing the Stage 2 Enterprise Survey by attaching a set of relevant questions to the Revised LFS in Stage 1 for the heads of informal production units identified. This modification is known as the 1-2 survey. 19 See footnote 15. Project resources can be found at: Countries included in the project were: Saint Lucia, Mongolia, Philippines, Sri Lanka, Palestine. The project lasted from

11 Concluding remarks This paper set out to provide some background on the non-observed part of the informal economy, the last NOE category we distinguished in an earlier paper. Measuring the informal sector is an important aim for many statistical offices, especially in developing countries, quite apart from any national accounts objectives related to exhaustiveness or NOE. We approached this topic historically via the recommendations and guidelines of the 15th ICLS, 17th ICLS, Delhi Group meetings and finally the ILO statistical manual on measuring informality. From the measurement perspective the boundaries between measurement of the informal and underground economies are not sharp, and much overlap may exist. Mixed household and enterprise surveys are often used for the measurement of the informal economy, with the survey being one particular example. To find out more, Measuring the Non-Observed Economy, OECD 2002, Chapter 10 The 2008 SNA, European Commission, IMF, OECD, UN, World Bank, 2009, Chapter25 Measuring informality: A statistical manual on the informal sector and informal employment, ILO