Informality and Inclusive Growth in Latin America: The Case of Colombia

The purpose of this research is to understand the impact of informality on inclusive growth in Latin America, and particularly in Colombia. The relationship between informality and inclusive growth is represented by two different hypotheses. According to the traditional view, informality constrains inclusive growth by restricting growth of the formal sector, draining resources from the public treasury and supplying low quality jobs that are unable to provide adequate conditions for a better standard of living. However, from another point of view, informality is a default alternative to unemployment, particularly among poorly educated individuals; a perspective that is rarely taken into account in Latin America. The case study of Colombia is relevant to the region, not only because Colombia demonstrates regional averages in terms of informality and inclusive growth, but also because the informal sector is highly heterogeneous and this allows for simultaneous testing of both hypotheses. Another interesting feature of Colombia is that it is one of the few countries that have implemented an active policy to reduce informality in recent years. As such, it is expected that the experience of Colombia will provide useful insight for countries facing formal labour market restrictions such as Argentina, Brazil and Costa Rica. Notwithstanding, the impact of any policy will vary depending on the specific characteristics of informality in each country. The analysis of the relationship between informality and inclusive growth has been understudied in general, perhaps because of the multiple channels that intervene in this relationship, as well as the lack of a consensus around the definition of both variables. For the purpose of this paper, we understand informality as those jobs or firms that are not regulated and/or do not contribute to public funds; and inclusive growth as growth accompanied by poverty reductions and equal opportunities for all segments of the population. Given this concept is rather broad, we have defined a set of inclusive growth indicators relating to the labour market as: employment, labour earnings, income distribution across different population groups, labour satisfaction, job stability and productivity. Exploring the way these variables impact inclusive growth is beyond the scope of this project. However, we have included in the literature review an assessment of evidence concerning the macroeconomic impact of informality, given the amount of externalities that tend to arise from individual labour decisions. One of the main conclusions of this paper is that an analysis of informality cannot be performed assuming that informal workers are a mass of individuals with similar characteristics. In fact, in Latin America informal workers range from poorly educated individuals including women heads of household and the older population, to highly educated young adults living in productive cities. This finding corroborates new literature which points to heterogeneity in labour markets in terms of the coexistence of three types of informal workers: the ‘structural’ informal worker, for whom informality represents a default option to unemployment due to poor education, skills or experience; the ‘induced’ informal worker who is segmented from the formal labour market due to high entry restrictions or to less obvious restrictions, such as segregation; and, finally, the ‘voluntary’ informal worker who chooses to be informal.