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Most workers in poor countries are in informal employment—self-employed in micro-businesses, agricultural work, or casual wage labor with no contract protections. The informal sector offers flexibility but low wages, no benefits, and limited growth. Debate centers on whether to formalize informal workers or create conditions for growth into formal employment.
From your study of structural transformation, you know that development involves shifting workers from agriculture into industry and services. But in most developing countries, this transition does not look like the textbook version where workers move from farms into factories with formal contracts and benefits. Instead, the vast majority end up in the informal sector — a sprawling category that includes street vendors, motorcycle taxi drivers, domestic workers, small-scale artisans, and subsistence farmers who sell surplus at local markets. Understanding labor markets in developing economies means understanding informality, because it is where most people actually work.
The informal sector is defined by what it lacks: formal contracts, legal protections, tax registration, social insurance, and regulatory oversight. A worker in a garment factory in Bangladesh may sew the same products as a worker in a factory in Germany, but without a written contract, minimum wage enforcement, workplace safety standards, or access to unemployment insurance. Informal self-employment is even more precarious — a woman running a small food stall earns income day to day with no safety net if she falls ill. The informal sector is not a marginal fringe; in Sub-Saharan Africa and South Asia, it accounts for 80-90% of total employment. Even in middle-income countries like Mexico or Indonesia, informality exceeds 50%.
Why is informality so persistent? One view, associated with the economist Hernando de Soto, sees it as a response to excessive regulation: burdensome licensing, taxation, and labor laws make formal operation too costly, so entrepreneurs rationally choose to stay informal. The policy implication is deregulation — make it easier to register businesses and hire workers formally. The opposing view, rooted in the structural tradition, argues that informality reflects a shortage of productive formal jobs: the modern sector simply does not grow fast enough to absorb the labor force, so workers have no choice but to create their own low-productivity employment. In this view, deregulation alone will not help — the binding constraint is the pace of industrialization and formal job creation.
The policy debate matters because the prescriptions diverge sharply. If informality is primarily a regulatory problem, governments should simplify business registration, reduce payroll taxes, and make labor laws more flexible. If it is primarily a demand problem, governments should invest in infrastructure, education, and industrial policy to accelerate formal sector growth. In practice, both forces operate simultaneously, and the balance varies by country. What is clear from labor market signaling theory is that formal employment carries an information value beyond the wage: a formal job signals reliability and skill to future employers, facilitates access to credit, and provides a platform for skill accumulation. Workers trapped in informality miss these compounding benefits, which is one reason why informal employment tends to be a persistent state rather than a stepping stone — and why labor market structure is so central to understanding why some countries develop faster than others.