Formalizing Economies to Fight Poverty

Emerging Voices features contributions from scholars and practitioners highlighting new research, thinking, and approaches to development challenges. This article is from Karen Tramontano, founder and president of the Global Fairness Initiative, and is part of an ongoing Development Channel series on global justice and development.

Sixty percent of the labor force in most developing countries works in the informal economy. Even though the informal economy is vibrant and provides essential services and goods to many communities, most governments disregard it. If governments instead sought to bring informal economies into the fold, they could enjoy substantial economic benefits.  Even more important, granting economic and legal rights to these overlooked workers and producers could lift thousands out of poverty—simply because social security is one of the most effective poverty-fighting tools that a government can utilize.

The Global Fairness Initiative (GFI), a non-profit organization I founded, works to expand livelihood opportunities for the poor through market-based interventions. In 2008, we launched a project in Guatemala to prove that formalizing workers and enterprises is feasible and can directly reduce poverty.  Because the Guatemalan government had almost no data on the informal sector prior to the project, GFI first surveyed informal workers and small enterprises to understand the dimensions and economic value of the sector. The results shed light on both the strengths and challenges of the informal economy. Community discussions, interviews, and surveys that GFI conducted revealed that workers were eager to escape the shadows of the informal economy, voice their opinions, and be taken into account by the government and its leaders. We found that many workers and producers were completely excluded from their country’s economic and legal framework: they lacked access to legal protections, fair wages, safe working conditions, and social safety nets and services. As a result, these men and women often worked harder and longer hours than their formalized counterparts and were among the most exploited and the least protected from harsh labor conditions.

GFI presented the government with statistics on the financial benefits of incorporating the informal economy, as well as information on how a more transparent labor force could attract more foreign direct investment. GFI also worked to secure the support of Guatemala’s civil society -- generally opposed to integrating the informal sector because of the tax burden-- as well as private sector actors nervous about the impact new formalized enterprises would have on their market share.

In the end, the Roadmap to Formalization in Guatemala was endorsed by all stakeholders. The Guatemalan government now understands the benefits of having a larger economy, and the private sector recognizes the benefits of competition and new consumers. The agreement committed the government to formalizing workers and enterprises and granting them social security and human rights. Since the roadmap was adopted in October 2010, Guatemala has used one of its central tenets--access to social security--as an incentive to formalize thousands of small enterprises through a “one-stop shop” system that streamlines enrollment in a wide set of government services, such as business registration, health care, and social security.

This approach is not without challenges.  First and foremost, the government must hold up its side of the bargain.  If informal workers and farmers meet their requirements to join the formal economy—namely by paying taxes—then governments are obliged to provide the promised benefits of formalization. Another daunting task is outreach to informal workers and farmers.  The government must engage the informal labor force.  Private sector and civil society step in to help the poor navigate and evaluate their new options. With transparent and meaningful engagement, the informal workers will begin to trust the process and see the benefits of the formal system. Formalization can reduce poverty, strengthen economies, and afford rights to those who need them the most.