Article at a glance:

The hidden dangers of the informal economy

Many companies around the world operate in the "informal economy," in which they underreport employment, avoid certain taxes, ignore product quality and worker safety regulations, violate copyright and intellectual-property laws, or even fail to register as legal entities. The problem is particularly acute in developing countries, where companies that operate informally produce as much as 80 percent of the output in some industries. Few policy makers are concerned, but they should be. By avoiding taxes and regulatory obligations, informal companies gain a substantial cost advantage that allows them to stay in business despite their small scale and low productivity and prevents more productive, formal companies from gaining market share. The result is slower economic growth and job creation.

The take-away

Reducing the size of the informal economy would generate huge positive economic gains. To reap them, governments must correct the root causes of informality—heavy tax burdens and complex regulatory schemes—and enforce the law more rigorously.