When thinking of informal entrepreneurs, it is common to visualize small producers or street vendors in developing economies, living in poverty and engaging in low-performing, labor-intensive activities conducted with manual tools. This is the most widespread image globally of informal entrepreneurs, but how accurate is it?
The evidence shows this image overlooks many ways in which informal entrepreneurs operate. From the clichĂŠ of poor rural people scratching a living from minimal resources to global organizations like Airbnb, the reality is much more complex.
Informal entrepreneurship is increasingly recognized as a legitimate, multilayered mode of business activity, in contrast to its historical status as an approach associated with deprived and impoverished communities. However, this is often not understood due to the difficulty in finding and navigating reliable data on informal enterprises, and despite the rapid growth of researchersâ and policymakers’ interest in these enterprises.
We decided to tackle this problem head-on by undertaking a review of the available literature (comprising 352 peer-reviewed journal articles). Our aim was to explore what informal entrepreneurship means in various contexts across the globe. This work enabled us to build a novel typology of informal entrepreneurs.
One of the most striking things we discovered in this process is how dynamic informal entrepreneurship is in practice, as entrepreneurs flex to get the best out of prevailing business conditions. Informal entrepreneurs move along the continuum of informality to either increase or decrease regulative legitimacy for their entrepreneurial activities â what we call âformalizing and informalizing pathways.â
For example, some entrepreneurs are âborn informalâ and establish their activities outside registration, or other laws and regulations, but become more formal over time. The opposite is also possible, with some entrepreneurs moving from formal to informal activities. Consider the scenario of formal vendors in an urban area struck by an unexpected natural disaster. They might continue their business without declaring taxes and could be required to provide emergency services to those in need without proper authorizations, while the government is busy handling the crisis. This represents an example of informalization driven by a sudden external circumstance.
To capture this dynamism, we identified three distinctive pathways along which informal entrepreneurs move, either acquiring or foregoing regulative legitimacy. These can be summed up as reactive formalizing, proactive formalizing, and informalizing pathways.
While informal entrepreneurs engage in some illegal activities such as not paying taxes or not registering their business with the relevant authorities, it is important to note that these activities are not criminal, nor illegitimate. Rather, they are socially accepted
Before looking at the pathways by which entrepreneurs move towards or away from formal status, it is necessary to define what we mean when we talk about âinformal entrepreneurs.â
Informal entrepreneurship in general has been defined as âentrepreneurial activities that are illegal yet remain legitimate to large groups in a societyâ (Webb et al., 2020, p. 511). While informal entrepreneurs engage in some illegal activities such as not paying taxes or not registering their business with the relevant authorities, it is important to note that these activities are not criminal, nor illegitimate. Rather, they are socially accepted and even the norm in the contexts where they are undertaken.
At the individual level, we grouped informal entrepreneurs into four types; within these groups, informality can be low, high, or partial:
Despite evidence that informal entrepreneurs are everywhere, even in developed economies (Godfrey, 2011), management scholarship tends to focus mainly on formal entrepreneurs â even though more than half of the market is moved by these âshadowâ entrepreneurs, many of whom are engaged, in one way or another, with formal organizations as well.
Relatedly, social acceptance of informal enterprise varies widely. In some regions, informal entrepreneurs do not face any sanctions and are openly accepted by the government. This is often the case in countries where formalization of enterprises is uncommon. And in developing settings, it is not always positive to push these entrepreneurs to formalize, because this may come too early in the development of a small enterprise. For example, if an entrepreneur is forced to register to pay taxes at an early stage, they may not be able to fulfill all the requirements, and some, especially the poor, may not have enough money to pay taxes. It is also common for entrepreneurs to try to hide their activities, instead of working in plain sight, to avoid attention from criminals.
Our research included an Italian buffalo mozzarella producer who decided not to comply with rules and regulations to avoid attention from the mafia and other criminal organizations. When small businesses such as this one register with the authorities, they often find themselves required to pay a bribe. Some degree of informality may help them to avoid this.
Some recognize informalization as an opportunity to work flexibly from home or take better care of the family during business hours.
There are two main formalization pathways that entrepreneurs can take: reactive formalizing and proactive formalizing. Informal entrepreneurs, whether poor or affluent, can move from low to high formality in a reactive manner. For example, when enforcement takes place regarding a law that was not previously enforced, entrepreneurs may be pushed to comply. When they find an appropriate opportunity, they start to formalize, whether by registration or other external drivers. This is what we call a reactive formalizing pathway.
Slowly, Airbnb, Uber, and other similarly disruptive companies started building legitimacy, creating momentum for their activity to be accepted by governments, and changing the perceptions of the public and regulators over time. This is what we call a proactive formalizing pathway.
Above we saw how reactive and proactive formalizing imply making efforts to increasingly comply with the laws and regulations in a certain setting. These pathways may require a belief in the capability to effectively comply with formal requirements, such as legal registration and formal operational structures.
Still, it can also work in the opposite direction: some ventures may be formal at the beginning but decide to informalize later. This is what happens along what we call an informalizing pathway. Some entrepreneurs decide to informalize to escape attention from criminal organizations. Some recognize informalization as an opportunity to work flexibly from home or take better care of the family during business hours. In response to extreme conditions such as war or natural disasters, some individuals might cease paying taxes. All these examples are drawn from informalizing pathways witnessed in our economies.
There is a growing focus on developing programs for entrepreneurs, to allow them to grow and to become more successful economically. Once this occurs, they are more naturally inclined to formalize to grow, for example by exporting or trading with bigger companies. In this context, sanctioning and punishment can be counterproductive.
By considering the prevalence of informal enterprises across different economies and the diverse universe of informal entrepreneurs, we can gain a better understanding of informal and semi-formal entrepreneurs and how formalizing can enable them to achieve higher performance, growth, and innovativeness.
A key message for policymakers, governments, philanthropic organizations, and social businesses is that standardized policies â which are often aimed at eradicating informal entrepreneurship or converting it into formal entrepreneurship â may prove ineffective if they do not consider the various levels of informality and socioeconomic status of individual entrepreneurs across different economies. By recognizing that informal entrepreneurship goes beyond skirting laws and regulations and is rooted in cognitive and normative environments, policymakers can design formalization policies that fit distinctive informal entrepreneurial types across different economies.
In all cases, formalization policies should be developed to suit the specific needs of informal entrepreneurs. For example, in the case of the informal and semi-formal poor who run micro-enterprises enabled by a powerful, hidden enterprise culture, formalization policies may be inadequate or even destructive. Instead of emphasizing sanctions for non-compliant behaviors, an alternate and more effective approach might be to incentivize entrepreneurs to grow their informal activities, which could then be formalized later.
Our study provides important insights for policymakers into the processes of reactive and proactive formalizing, as well as informalizing. To achieve more effective results and social outcomes over time, it is necessary to identify the pathways along which individual entrepreneurs evolve, as well as the main causes and strategic decisions they make to do so. Armed with this knowledge, it is possible to provide helpful interventions and support.
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