The Logic of the Informal Economy

CAMBRIDGE – A specter is haunting the world’s developing countries – the specter of the “informal” economy. For some, the informal sector includes all businesses that have not been registered with the authorities. For others, it refers to businesses that escape taxation. The International Labor Organization defines it as comprising firms that are small enough to fall outside the labor code.

Whatever the definition, what has concerned many economists and gained policymakers’ attention is that the size distribution of firms in developing countries has a long tail. Compared to developed countries, an unusually large number of small, unproductive firms coexist with a small number of large, productive firms.