Transitioning the informal economy to a formal one

• by Manoj Nayak, Rhifa Ayudhia and Lenny Nurharyanti Rosalin
• Jan 16, 2023
• 5 min

Developing countries often prioritize the formalization of enterprises in their MSME development policies. The benefits of formalization include increased access to credit, higher productivity, and better social protection, while governments gain from a higher tax base. However, informality continues to persist despite these apparent benefits.
This blog stresses on the need to modulate our approach to formalization of the informal economy and explores three principles on how the digital economy can enable this process.

We express our sincere gratitude for the support from the Deputy Minister Ms. Lenny Rosalin from the Ministry of Women Empowerment and Child Protection, Indonesia on this engagement. However, the views expressed in this blog does not necessarily represent the view of the Ministry. 

This blog is the last of our three-part series on women’s participation in the digital economy. It is an outcome of MSC’s work with the Ministry of Women Empowerment and Child Protection in Indonesia for the G20 Ministerial Conference for Women Empowerment. Read earlier blogs in this series  .

The informal economy provides jobs for 61% of the global workforce. This large workforce has low skills and productivity levels, irregular income, unsafe working conditions, and lacks access to credit. As seen during the economic fallout of COVID-19, a large informal workforce leads to a vulnerable population because workers lack adequate social safety nets.

Developing countries often prioritize the formalization of enterprises in their MSME development policies. The benefits of formalization include increased access to credit, higher productivity, and better social protection, while governments gain from a higher tax base.

Despite these apparent benefits, why does informality persist?

In this final blog, we explore the need to modulate our approach to formalization and how the digital economy can enable this process.

Align the policy imperatives of formalization with the needs of the informal economy

Informality in low- and middle-income countries persists, partly due to the lack of formal employment opportunities in the economy. In addition, the compliance costs associated with formalization incentivize firms to remain small and informal. Further, the imperatives of competition and globalization force certain employers, such as in the garment industry, to convert formal jobs with benefits into informal piece-rate work with no benefits.

In addition, women in the informal economy must adjust to the realities shaped by social norms and domestic responsibilities that control the nature of economic opportunities available to them. These challenges ensure that formalization is not a choice for most women.

Therefore, policy objectives should reduce rigidity around the formalization process. Policies should focus on supporting incremental formalization that offers tangible benefits regarding access to credit, information, and markets at a low cost.

The rise of digital platform models in the digital economy offers a unique opportunity to support the informal sector’s transition to a more formal workforce. We discuss the unique attributes of digital platform work and the possibilities for greater formalization, focusing on women in the informal economy.

The digital economy can lead to achieving greater formalization

Digital gig platforms serve as intermediaries that connect service providers and customers at scale. These platforms operate in informal sectors, such as taxi and ride-hailing services, delivery services, home services, domestic help, and beauty services.

The business model of digital platforms offers an on-ramp to greater formalization in the workforce. We outline four areas where digital platforms can lower the barriers to the formalization of women’s work.

1. Availability of data: As an aggregator of services, digital platforms are repositories of data on the workforce and their economic engagements.  Access to platform data can address the challenge of low visibility over informal employment, which impedes the government’s ability to design better policies for the informal economy.
2. Skilling of the workforce: The business models of digital platforms and their success depends on high levels of consistent customer service. Platforms invest in standardizing and upskilling workers to meet higher standards. The experience and association with platform companies can lead to a better perception of women’s skills.
3. Access to formal financial services: Platform work enables formalization efforts because workers receive payouts regularly into their bank accounts or digital wallets. Building financial histories increases their chances of accessing financial services, such as credit and insurance.
4. Increased productivity: Workers can access better services on digital platforms, such as job discovery and matching services. These platforms allow informal workers to find more work compared to a traditional offline market.

However, despite this potential, multiple   across countries highlight how platform workers struggle to access fair pay, fair working conditions, and fair contracts.

G20 member countries must focus on a multipronged policy approach to ensure the growth of the digital economy leads to more formalization. We discuss some potential principles of such policy measures.

Principles that can support women informal workers on digital platforms

1. Use data to make informed choices on support to workers

As Galperin and Randolph suggest, policymakers and regulators should forge partnerships with platforms to access this data to understand the work and workers better. This data can then inform policies on the classification of workers, their roles, the responsibilities of the platforms toward workers, and the role of the government, among other areas.

2. Governments should encourage the creation of an ecosystem of service providers that can support women workers’ efforts to formalize

An important consideration for women workers and entrepreneurs to become more formal is the move’s cost-effectiveness. They face particular challenges as they interact with platforms in the digital economy. Women need increased access to various services as they grow within the digital economy. These services can include skill and capacity building, technology products, taxation and compliance management, and other nonfinancial business development support.

Policymakers should create an enabling ecosystem of service providers, civil society organizations, and individuals to effectively offer these products and services to women workers that lower formalization costs. An example of such an enabling ecosystem is the Women Entrepreneurship HUB (WE HUB), run by the Government of Telangana in India. The initiative gathers stakeholders, such as government departments, corporates, industry, academia, and individuals, as mentors to support female entrepreneurs.

3. Support the development of alternative economic models for the digital economy

Women collectives and cooperatives have long been part of developmental strategies for women’s empowerment. These networks allow women to collectively benefit from increased economic interactions and lower the chances of failure.

Digital technologies have helped create an alternative model for digital platforms that workers can own and manage. These platforms offer a different version of growth-centering worker benefits. Governments need to support measures that promote the development of such alternate models.

The digital economy offers an opportunity to bring many informal workers into the formal economy. This increase in formalization will help develop a skilled and productive workforce and improve the economic resilience of workers. However, realizing a truly inclusive digital economy will depend on the worker-centric transition of the informal economy to an inclusive formal one.

This three-part blog series discussed the issues and challenges of women’s participation in the digital economy. We argue that governments, private sector players, and other stakeholders must understand the nature of women’s economic interaction in the informal economy and   customized support that increases their ability to continue in the labor force. Our recommendations can help develop a more formal, inclusive, and resilient digital economy.