Formalization of the Informal Economy

What is the informal economy? Why is formalising the informal economy necessary? What is an e-government approach? In answering these questions, this introductory chapter sets the scene for the rest of this book on how digital technologies can facilitate the transition to formality. It commences by reviewing the various adjectives and nouns used to describe socially legitimate paid activities that are legal in all respects other than they are hidden from, not declared to, or unregistered by the authorities for tax, social security, and/or labour law purposes when they should be reported, declared, or registered. Attention then turns towards why formalising the informal economy is necessary. This reveals that any beneficial consequences of the informal economy are far outweighed by its harmful consequences and that most benefits of the informal economy are only beneficial if this economic activity is subsequently brought into the formal economy, meaning that action is required by governments to formalise the informal economy. The third and final section then turns to how this can be achieved. This introduces the emergent e-government approach that digital technologies applied in public initiatives, programmes, and policies can be an effective means for accomplishing this transition to formality.

This chapter explains the reasons for participation in the informal economy and then shows how an e-government approach addresses these reasons. To do so, the starting point is recognition that over the past decade there has emerged a consensus on how to explain the informal economy. Previous theorisations of the informal economy have been synthesised by neo-institutionalist theory which explains the informal economy as arising when formal institutional failings lead to a gap between the formal rules of the game and social norms. Therefore, the first section of this chapter presents this neo-institutionalist theory. With this explanation in hand, the second section then discusses how an e-government approach can address the formal and informal institutional failings that result in participation in the informal economy. Third, and to display that there is indeed a relationship between improving e-government and participation in the informal economy, the current empirical evidence is reviewed that overwhelmingly reveals the statistically significant positive relationship between e-government and formalisation.

This chapter examines the range of e-government tools available to authorities to facilitate the transition to formality. On the one hand, it sets out the digital technologies that tax, social security, and labour authorities can use to enforce compliance with the laws and regulations among businesses, employers, workers, and citizens. These include multifarious deterrence e-tools that increase the real and/or expected costs of participation in the informal economy by improving the risk of detection and sanctions, along with a variety of e-tools to make participation in the formal economy easier and more beneficial on both the supply and demand sides. On the other hand, it sets out a range of digital technologies that can be used by enforcement authorities to encourage voluntary compliance. These are again of two types, namely, education and awareness-raising e-tools to change social norms and various e-initiatives to modernise formal institutions by making them more customer-friendly, not least to improve trust in government. The outcome is a review of the full e-toolbox available to authorities to facilitate the formalisation of the informal economy.

This concluding chapter provides a future roadmap for countries seeking to pursue a transition to formality using digital services, along with fruitful future directions for research. Synthesising the arguments of the book, the first section summarises what is meant by the informal economy and the range of consequences of its existence for different stakeholders, to reveal why a roadmap is required to formalise the informal economy. To develop the roadmap, the next section then identifies the determinants of the informal economy and how an e-government approach addresses these determinants. To highlight the multifarious e-government tools available for doing so, the third section outlines the full e-toolbox available to enforcement authorities to formalise the informal economy. The fourth and final section then draws out some summative remarks on an e-government approach and the future research required.