Formal is better; informal the scourge. While I still remain largely in that camp, I have to say that an article in today's Financial Times gave me some pause on this question.
Growing up in a middle-class household in the U.S. Midwest left me with a world view that is intrinsically oriented to the formal economy — or at least, so I thought. My grandmother, may she rest in peace, was an amazing woman and indeed the main entrepreneur who I have had in my life and yet I doubt very much that she always reported all of her income. A highly ethical woman in my estimation, she was widowed with three children (one under 1) at about the age of 30 and went on to send all of them to college while living independently and only remarrying briefly. At the age of 88, she was still running her own seasonal business for most of the year and beating me handily at any game that we engaged before her death. Just as she probably used a bit of creative accounting to get by at certain times, today's article points out some of the ways in which certain economies are likely surviving currently because of their informal economies.
I have spent a lot of time in Spain in the recent year which has brought me head long into contact with the informal economy. Indeed, when first here, I have to say I nearly burst a blood vessel trying to deal with some of the things which could only be done in the informal economy, which I was used to being formal.
I had some of my most heated arguments and grandstanding trying to deal with people who, by all appearances, were part of the formal economy but apparently were not. As the article rightly points out, Spain's informal economy must be among the biggest in the developed world. And yet, with all of the economic pain and tumult in the Spanish economy, by my reading of currently available data Spain is the hardest hit country anywhere in terms of pre-Crisis and post-Crisis impact on new business formation and the existing small business sector; however, the Spanish economy is still functioning.
Yes, there have been some significant protests, but as I think the article correctly identifies, if Spain didn't have some of this informal economy there is no way that it would not be in a revolutionary state. (I am not sure it won't reach that state but it's not there currently.) If the government wants to bring some of this informal economy into the formal economy, which seems necessary for longer-term growth potential, then it needs to face facts about the repressive regimes which remain in place for many formal business and other activities.
That said, in my opinion, Spain has no choice but to live with its informal economy currently as the changes that it needs to make to much of its burdensome regulatory and other regimes will take time and seem deeply, deeply rooted in culture and society.
Well, that is all a bit of an aside probably for most of my readers. I offer it only in the way of saying, this topic of informal economy measurement is extremely important. Many of the data projects we have funded only focus on the formal economy because high-growth companies need to be operating formally (OECD and World Bank), but I am sure that this set of measurement issues is important and indeed will likely be incorporated by many scholars as a measure of institutions in different countries.
The Financial Times article is data-driven, offering estimates from Friedrich Schneider that appear to be the going standard in this area, but it also has a nice discussion of the dangers of measuring the informal economy over time. I would expect that we will see a lot more measurements of the informal economy as the markers of business and household activity (all the data we are leaving in our daily activities) explode in the coming years; it is these data, or things like electrical consumption, that seem most common bases for estimating the actual business activity in a country. Those interested in this area should check out the article, or the longer journal article, which I have been told by experts at the World Bank is where they currently draw from:
Schneider, F. and D. Enste, 2009. Shadow economies: Size, causes and consequences. Journal of Economic Literature, 38(1): 77-114.
Here is a sneak peak at some of the data the Financial Times presents:
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