What does formal mean anyway?

I can’t stop thinking about Mohammad’s post on the benefits of formalization.

His post lists nine potential benefits to firms from formalization. You can check out the post to see the complete list. I was particularly interested in the potential benefit of “Better access to workers.”

As a labor economist, I think a lot about the benefits of being a formally-registered worker. In many countries, being formally registered entitles the worker and the worker’s family to government-provided health care. Maybe a pension when the worker retires as well. Firms might find it hard to attract workers if the workers don’t get these benefits.

I was surprised to see that “Better access to workers” came in last in importance among the nine potential benefits. Less than half of the firms reported that they would have better access to workers by being formally registered. Do workers even care if they are formal or not?

I think they do. We just need to be very careful about what it means to be formal.

If I were forced to come up with a definition of a formal-sector firm, I would say that a firm is formal if it is registered with the income (or profit) tax authorities. I think the Enterprise Surveys use a similar definition. There is plenty of room for nuance in that definition, although that’s a debate for another time.

If I also had to come up with a definition of a formal-sector worker, however, I would not say that a worker is in the formal sector if the worker’s firm is in the formal sector. I would say that a worker is in the formal sector if the worker is registered with the relevant authorities (social security, for example) and is therefore entitled to the government-provided benefits offered to formal-sector workers. It is common for formal firms to have many informal workers.

If the Enterprise Surveys asked about the benefits of registering workers with social security, maybe the answers would be different.

The lesson here is that informality is a very complex issue. It is also an important issue and I’m happy that the Enterprise Surveys are beginning to give us more information.