World Bank says informal sector issues could slow recovery from COVID-19

• New study finds drawbacks of informal sector slows recovery from COVID-19 impacts
• Says countries with larger informal sectors farther away from achieving SDGs
• Points out informality in South Asia largely due to low human capital and large agricultural sectors
• Sri Lanka has the highest informal output share in the region, at 35 percent of GDP in 2010-18

Governments in emerging markets and developing economies (EMDEs) such as Sri Lanka are urged by the World Bank (WB) to adopt a comprehensive set of policies to address the drawbacks of informal sectors, which otherwise will hold back the pace of recovery from COVID-19.

Sri Lanka has the highest informal output share in the region, at 35 percent of GDP in 2010-18, while India has the lowest, at 17 percent. 

However, the order is reversed when considering employment informality, which was 76 percent of total employment in India in 2010-18 and 42 percent in Sri Lanka, reflecting greater disparities in labour productivity between the formal and informal sectors in India than in Sri Lanka.

A new WB Group study revealed that a “strikingly large” percentage of workers and firms operate outside the line of sight of governments of EMDEs, a challenge that is likely to hold back the recovery in these economies unless corrective policy measures are rolled out.

The study found that while the informal sector accounts for more than 70 percent of total employment of EMDEs, such scale diminishes the abilities of these countries to mobilize fiscal resources needed to bolster their economies in a crisis, to conduct effective macroeconomic policies, and to build human capital for long-term development.
“High informality undermines policy efforts to slow down the spread of COVID-19 and boost economic growth. 

Limited access to social safety nets has meant that many participants in the informal sector have neither been able to afford to stay at home nor adhere to social-distancing requirements. 

In EMDEs, informal enterprises account for 72 percent of firms in the services sector,” highlighted the WB in the finding of the study titled ‘The Long Shadow of Informality: Challenges and Policies’. 

The analysis pointed out that high levels of informality generally means weaker development outcomes and countries with larger informal sectors have lower per-capita incomes, greater poverty, greater income inequality, less developed financial markets, and weaker investment and are farther away from achieving the goals of sustainable development.

The study revealed that government revenue in EMDEs with above-average informality totaled about 20 percent of GDP, which is five to 12 percentage points below the level in other EMDEs. 

While government expenditureis also lower by as much as 10 percentage point of GDP, the ability of central banks to support economies is constrained by underdeveloped financial systems associated with widespread informality.
The analysis highlighted that informality in EMDEs varies widely across regions and countries and is the highest in Sub-Saharan Africa (36 percent), and lowest in the Middle East and North Africa (22 percent).

Meanwhile, in South Asia and Sub-Saharan Africa, pervasive informality is largely the result of low human capital and large agricultural sectors, whereas in the Europe and Central Asia, Latin America and the Caribbean, and the Middle East and North Africa, heavy regulatory and tax burdens and weak institutions have been important factors in driving informality, the WB said.

To address the issues stemming from informal sectors, the WB proposed five general recommendations policymakers could follow.

The recommendations were; take a comprehensive approach; tailor measures to country circumstances because the causes of informality vary widely; improve access to education, markets, and finance so that informal workers and firms can become sufficiently productive to move to the formal sector; improve governance and business climates so the formal sector can flourish; and streamline tax regulation to lower the cost of operating formally and increase the cost of operating informally.