From the informal economy to the meaning of informality: Developing theory on firms and their workers

Introduction

Mainstream entrepreneurship and management scholarship has traditionally had little to say about the topic of the informal economy. That fact inspired the conference theme of the 2012 Academy of Management Annual Conference, two pieces in the Academy’s Perspectives journal (Bruton et al., 2012; McGahan, 2012); and there are also other recent overviews (Godfrey, 2011). Entrepreneurship scholars are following suit (De Castro et al., 2014; Webb et al., 2013). These contributions underline the extent of the “informal economy” and the need to understand it better. Among other things, the informal and the formal intersect, with large “formal” firms depending on supply chains in which various “informal” practices can operate undetected.

We need to understand the origin, nature and extent of “the informal” in modern economies, not least because of the potential for sometimes ill-informed controversy. Unless carefully placed in its proper context, economic informality can easily be equated with criminality and rendered rather over-dramatically as a “shadow economy” (Schneider, 1997), a ghostly bogeyman lurking just around the corner. This is all the more reason for further development of these themes, drawing upon various sources hitherto seen as peripheral to the discourse. Notable here are important works by earlier US scholars who have provided a great deal of basic definitional work in the field (Castells and Portes, 1989; Sassen, 1991; Waldinger, 1993). Additional strength might be derived also from a fast emerging European school (Edwards and Ram, 2006; Ram et al., 2001; Williams, 2006, 2014), a potential source of theoretical interpretation and empirical findings capable of enriching the insights from management theory highlighted by McGahan (2012).

Building on this, our purpose in this paper is to lay out some ways in which informality can be understood while also offering a synthesis of knowledge in an emerging area of management scholarship. We explain and apply two long-established theoretical approaches: “mixed embeddedness” (ME) and “workplace sociology” (WS). We argue that bridging these two influential theoretical tools will enhance the way informality has been analysed so far, and fill some of the aforementioned gaps. ME has had a powerful influence on studies of immigrant entrepreneurship (Rath, 2000) and it has been developed and integrated into more general frameworks that explain behaviour in small firms in a variety of contexts (Edwards and Ram, 2006). It encompasses three levels of analysis: the micro characteristics of firms themselves; the opportunity structure in which they find themselves; and the ways in which this structure is itself socially embedded (Kloosterman et al., 1999; Kloosterman, 2010). It offers a way of understanding the interplay of the firm and its environment. Hence, ME helps to understand informality as a result of the intersection between the regulatory framework, the market and the firms. Informality is explained as the product of exclusion from all but the lowest yielding markets, which tends to marginalise the smallest firms, creating a need for cost-cutting, which is often achieved by means of informal practices. However, ME does not account for the dynamics within the firms at the micro-level that create and sustain informal practices. It is silent on the institutional, social and individual relations between owners, workers and other relevant actors that might produce informal practices.

We argue that WS is helpful in explaining the mechanisms that (re)produce informality. WS has for many years discovered and analysed informality in the employment relationship. Lupton (1963), for example, explored “fiddles” in an engineering workshop. The most extensive treatment came from Mars (1982), who addressed ways in which workers secured illicit rewards. Despite the fact that WS theory has been embedded in the study of work relations since the 1970s, it is rarely used in the study of informality. The perspective addresses the meaning of conflict and co-operation; it applies even in “informal” activities even though these lack many of the formal structures, notably trade unions, usually associated with ideas of conflict and contestation (Thompson and Smith, 2009). A core insight of WS is the complex, widespread and heterogeneous nature of informal economic activity; and its intimate connection with the “formal” economy. This immediately renders problematic approaches to the informal economy that portray an informal firm as an entity that is wholly informal.

The paper synthesizes and builds on evidence published in core management journals (Edwards and Ram, 2006), organisational behaviour (Edwards et al., 2006), and work and employment (Ram et al., 2007). The studies documented in these sources take the form of intensive case studies and incorporated the neglected voice of workers as well as business owners.

It is organised in two major sections: the Origins of informality and the Nature of informality. We highlight how WS and ME have helped to explain different aspects of informality in small firms illustrative empirical material analysed using these two theoretical approaches. These examples analyse different aspects of informality mainly within the ethnic economy in the UK (Ram et al., 2007; Jones et al., 2004, 2006). Given the overall marginalisation of these firms from the mainstream economy, immigrant enterprises prove a suitable case to look at the suitability of WS and ME to explain informality within small firms. However, this sample material does not preclude the extrapolation of these theories to understand processes of informality within small firms in the mainstream economy. We include a final section where we outline future directions of research.

Origins of informality

Bruton et al. (2012, p. 1) define informal firms as those that are unregistered but derive income from producing legal goods and services. Here it is important to note that the notion of economic informality covers the whole range of business transactions carried out on a non-contractual basis. These include such practices as recruiting workers via the community “grapevine” rather than employment agencies or carrying out what Williams and Windebank (1998) call “paid favours” for friends and family. Significantly these are absolutely non-transgressive in nature, without a hint of law violation. While we employ a variety of descriptive labels in the present paper – “informality”, “informal firms”, “informal practices”, etc. – these are purely rhetorical devices and we regret there is as yet no recognised terminology to distinguish transgressive from non-transgressive. Until the requisite neologism is invented, Bruton et al.’s (2012) offers a valid starting point in harmony with the prevailing view in social science, as expressed by Williams and Windebank (1998, p. 4), who describe informal employment as “the paid production of goods and services that are unregistered by, or hidden from, the state for tax, social security and/or labour law purposes”. Broadly echoed also by Grabiner (2000), Leonard (1998) and Williams (2004), this formulation explicitly distinguishes informal work from both formal activities on the one hand and criminality on the other. Closely bearing on the kind of research we ourselves have done on informal work (Ram et al., 2007), Williams and Windebank (1998, p. 4) proceed to expressly draw attention to non-registration as a means of “avoidance of labour legislation, such as employers’ insurance contributions, minimum wage agreements or certain safety and other standards in the workplace”.

The origins of informality were addressed powerfully by the marginalisation thesis, originally put forward over two decades ago by Castells and Portes (1989), which sees informal work as an inherent feature of advanced capitalism, attempting to explain this by reference to the chronic disequilibrium of the market, which forces many micro-firms to sell their product or service at below the “correct” price. Since they can only achieve this through severe cost-cutting, they are obliged to cut all manner of regulatory corners.

All this is given a valuable historical context by Williams (2014), who examines the development of thought in this field from the early twentieth century to the present. Most pertinently he reminds us that before the 1980s the prevailing view was that economic informality was an obsolete and vanishing form, mostly confined to pre-modern regions of the world. Insofar as it continued in the modern economically developed world it could be dismissed as a residual “gradually disappearing from view as the modern formal sector became totalising and hegemonic” (Williams, 2014, p. 1). Yet, from the 1980s onwards the realisation began to dawn that this rather casual assumption was empirically flawed, that even in the most advanced economies the population of firms operating at least partially on an informal basis was not diminishing. In response to this emerged the political-economic perspective led by Castells and Portes (1989), maintaining that far from existing falteringly as obsolescent residuals, informal economic activities are a congenital feature of advanced capitalism. Indeed, under the pressures faced by small entrepreneurs and workers in face of the “outsourcing, downsizing and subcontracting practices that have appeared under deregulated global capitalism” (Williams, 2014, p. 2), the conditions for informal activity have intensified. As Sassen (1996) has argued, much informal activity takes the form of self-employment as last resort survival for marginalised workers, who use their firms trading activities to evade all manner of regulatory costs (Slavnic, 2010; Ram et al., 2007).

From the start of the present century, this marginalisation thesis has almost inevitably come under challenge from the newly hegemonic neo-liberalism (Harvey, 2005), what Chang (2014, p. 70) regards as “the dominant economic view since the 1980s”. The neo-liberal interpretation stands the marginalisation thesis on its head, placing the entire necessity for evading regulations on the state itself (Becker, 2004; De Soto, 2001) rather than on the market’s creation of a disadvantaged sub-class of self-employed strugglers. Summarising this neo-liberal thesis, Williams (2014, p. 7) puts it thus, “workers […] in regimes where there is too much state interference in the workings of the market, high taxes and corrupt public sectors are making the rational economic decision to voluntarily exit the formal economy”. Tellingly this author has himself conducted exhaustive international tests on all the key neo-liberal hypotheses, coming to the conclusion that there is little or no empirical support for any of them (Williams, 2014). Yet even though it may be over-harsh to dismiss the evidence-free neo-liberal case as ideologically driven, we can hardly fail to note its reliance on faith rather than concrete proof. Whatever the truth of this, it is still the case that the controversy surrounding informal motivations remains alive, as we shall see later when revisiting our own work on UK government enforcement of regulations (Ram et al., 2007).

Further hampering any search for neat black and white interpretations is the realisation that informality is not a linear one-dimensional affair but one that it is better seen as multi-factorial process. Accordingly, we ourselves adopt the “cocktail of factors” thesis developed by Williams (2004). Not only do a wide range of economic, social and geographical processes come together to nudge some individuals towards unorthodox working practices but the complex multiple causation also tends to create a broad spectrum of activities. Indeed these range from fairly hard-line regulatory evasion at one extreme to what he calls “informal social entrepreneurship” (Williams, 2004), the undertaking of paid favours for friends and neighbours.

According to this approach, a distinct “informal” or “underground” economy is a rather tiny fraction of the great range of actually existing informal activities. Indeed, Williams and Windebank’s (1998) rejection of the term “informal economy” in favour of “informal employment” expressly makes the point that formal and informal firms are not separate species. Much more common than the pure formal or informal firm is the dual identity firm and any temptation to search for binary distinctions must be resisted, when reality tends to resemble a continuum, further complicated by all manner of overlaps. In practice, informal operators may well adopt formal procedures in certain circumstances, while the converse is often true. Attempting to bring some sort of order to this highly variegated realm, Williams (2014, p. 3) maintains that at a broad level, there are three categories of interest in this field: (1) informal firms operating informal practices (2) informal firms operating some formal practices, and (3) formal firms operating some informal practices. Only Category 1 fulfils the conventionally accepted criteria for the “pure” informal firm and in practice it is comparatively rare, outnumbered in most places by Category 3.

Though this dichotomous framing of the formal vs the informal economy has still not been entirely abandoned in management and entrepreneurship studies, it is refreshing to note a dawning awareness of the limitations of binary formulations (Bruton et al., 2012; Webb et al., 2013). In line with Williams (2014), Webb et al. (2013, p. 611) note that “entrepreneurs can be fully compliant with certain legal definitions (i.e. labor regulations) while in conflict with others (i.e. trademark laws)”. Future studies, they argue, could examine “how entrepreneurs are both formal and informal and why, from a strategic standpoint, an entrepreneur would choose to be compliant with certain prescriptions while intentionally conflicting with others” (Webb et al., 2013, p. 611). These ideas featured in an inner city restaurant in Birmingham, UK, that we investigated in research on informal work (studied by Ram et al., 2007, with subsequent further contact). It was registered for tax and other purposes and had an up-market position. Yet it employed many of its workers “off the books” and evaded some regulations, notably the National Minimum Wage (NMW). In doing so, it was not simply “exploiting” its workers. Rather, it was negotiating their consent, which embraces some autonomy in the labour process and leisure when the restaurant was not busy. It was thus formal and informal, it was embedded in the economy in particular ways, it had a distinct way of managing the labour process, and it illustrates a type of informality.

In explaining the extent of informal activities, ME is of value in spelling out the origin of informality as the interplay between firms’ own resources and the opportunity structure in which firms operate. This orientation can usefully address important questions that Bruton et al. (2012, p. 9) maintain are neglected: are “some individuals […] excluded from formal opportunities due to cultural/societal biases […] and pushed into informality?” “If so, does this business type form an opportunity for these individuals, or does it create its own barriers that limit the individuals from progressing?”, and “what are the motivations that cause a firm to transition from informal to formal”. We have, for example, studied the informality associated with firms’ evasion of the UK NMW and also the employment of workers in the country illegally (Ram et al., 2007; Jones et al., 2004, 2006) using ME. The main processes leading to these results were two. First, firms were under product market pressure to contain costs in the two sectors studied. Restaurateurs made repeated reference to the clustering of rival firms, commenting on the “cut-throat” nature of the competition and “trying to outdo one another”. And for nearly all employers in clothing, survival rested upon price-cutting, sourcing cheap imports, and a retreat from manufacturing. Second, the labour market continues to supply workers willing to work for extremely low wages. The reluctance of workers to challenge non-compliant employers has to be seen in the context of the paternalistic bargain prevailing in such firms; this bargain had its roots in familial and community links. This work also shows that the informal labour process varies quite markedly from one sector of economic activity to another, with workers in customer-facing jobs like restaurant waiting enjoying considerably more autonomy in personal time management than their more regulated counterparts in clothing factories. By linking ME with WS together, we capture not only the origin of informality but also its reproduction and sustainability.

Irrespective of sector, however, a key finding of that research is that, though this harmonious equilibrium is paradoxically unstable, it is constantly being remade, as for example with the use of new groups of workers to plug recruitment gaps resulting from growing dissatisfaction with wages and conditions. In the case of South Asian employers it is worth noting the acute contradiction between the need to recruit fresh labour from the homeland and the UK immigration laws which make this a legal impossibility in most cases. Hence the pressure to use irregular immigrants is intensified, a highly precarious “solution” very much regretted by many owners themselves. As explained by one of the respondents in our own survey of irregular immigrants, “If I could get workers who are legal, I’d prefer to. We need a new system whereby we can get workers from Bangladesh legally, because the legal workers no longer move into the restaurant business” (Jones et al., 2007, p. 413). Even though we need to guard against false protestations, nevertheless this quite typical statement strongly suggests that entrepreneurs who otherwise would prefer the psychological security of a law-abiding existence do not conduct regulatory evasion in an atmosphere of impunity but rather as a last resort imperative. Another respondent who laments, “I only employ illegals because you can’t get anyone else, casts further light on this. These days the youngsters want official jobs or they’re just into drugs and criminal activities” (Jones et al., 2007, p. 413). Such are the strains of the immigrant to British-born inter-generational shift. These examples illustrate the use of ME as a valid tool to capture the origin of informality through the interplay of the regulatory framework (i.e. immigration regulations in the UK) and the practices and mechanisms of the sector where the small firm is embedded.

Whatever the moral qualms of the participants interviewed for the study on NMW, these irregularities are reinforced by the absence of an effective external deterrence from the state. Often the latter is torn between the need to impose its own authority and the need to conserve the socially valuable jobs created in impoverished neighbourhoods by informal employers (Freeman and Ogelman, 2000; Jones et al., 2007). ME also accounts for how the state structures the spaces and practices in the market for firms to operate. In this particular case, the state could be seen as a direct facilitator of informal economic activity. In effect, the more the state regulates, the more regulations there are to evade and each new regulation inevitably acts to criminalise those who simply carry on as before. In this sense the modern state is the virtual creator of the informal sector through its constant redefinition of what is non-permissible in the market place. Even so any political reluctance to crack down on informal evaders seems almost justified in the light of historical experiences like the1990s Dutch attempt to enforce regulations on the Turkish-owned clothing industry of Amsterdam, whose only achievement was to bring about the near-total extinction of that industry (Raes et al., 2002).

Harking back to our earlier account of Williams (2014), we are reminded that all this is highly politicised, with far-reaching implications for the role of the state and its relations with the market. Consequently this line of argumentation needs to be carefully measured and contextualised. For example, Castells and Portes (1989, p. 27) state that, “Avoiding over-burdensome tax regulation provides an incentive for tax evasion, welfare benefit abuse and a multitude of other activities aimed at earning invisible income”. Taken without qualification, such a statement suggests extreme bias, aligning itself with neo-liberals like Lea (1996) for whom any kind of state regulation is an offence against rational free market economic behaviour, creating a vicious circle in which informality reduces the state’s tax revenues thereby leading to higher taxes and still more evasion. Yet a more balanced interpretation might be that, culpable though avoidance may be, its root cause is a macro-economy so skewed in favour of large corporations that many small enterprises are too marginalised to be able to earn an “honest” living (Jones et al., 2006). Judgementalism is hardly appropriate to such moral ambiguity, with value judgements about informal work appearing even more slippery than attempts to define it.

On transitions between the formal and informal, ME also helps us to account for the impact of regulations in the sectors, that push firms in both directions. On the one hand, firms can be pushed towards informality when squeezed by external pressures such as the UK NMW in the context of very strong market competition. Alternatively, the NMW can encourage formalization when it goes along with the opening of market niches that allow the production of higher-value added products. Once again, the very nuanced interaction between state policy and entrepreneurial practice is at the heart of this question, as became very evident to us during our investigation of 17 clothing and restaurant firms not complying with the NMW (Ram et al., 2007). From this exercise our key finding was that, in carrying on much as they had prior to this legislation, informal employers remained all but immune to the NMW, evading it by under-declaring the number of hours worked. Particularly in the restaurant trade, employers insisted that hourly rates were completely inappropriate to working times, which varied wildly according to fluctuations in customer numbers. Accordingly most of them echoed the respondent who dismissed the NMW as “having no influence at all. It’s just another level of bureaucracy we have to deal with”.

A small minority of firms in this study (Ram et al., 2007) did make the transition from informal to fully compliant businesses. Three factors were particularly important in effecting this transition. First, market context was crucial. The firms were intent on growing their businesses; their customer and supplier base comprised larger firms that often exercised some influence of the internal operations of the case study companies; and the formal and contractual basis of customer relations meant that there was limited scope for non-compliance. Second, compliance was also a product of managerial choice. Non-compliance was incompatible with the owners’ desire to grow the business, encourage commitment and innovation amongst staff, and secure high value customers. Finally, a noticeable feature of the compliers was their active involvement in a variety of business networks. These owners: made extensive use of their local business advisory services, secured business-related grants from the local council, and were business owners were members of local employer associations.

These illustrations of the impact of NMW regulations demonstrate the value of ME in explaining the origin and informality. Linked with WS, it can also account for the process to more formal arrangements. The state and its diverse regulatory framework (i.e. immigration policy, NMW, enforcement of controls) explain the origin and perpetuation of informality.

Nature of informality

Whilst ME sheds light onto the origins of informality, WS helps us understand the negotiation of informal work relations. This is to say that ME accounts for the origin of the informal practices, but it does not have explanatory capacity to unveil the mechanisms behind informality. At the micro-level we ought to understand how entrepreneurs and workers comply, semi-comply or contest informality. Some scholars have speculated that the “whip of the market” (Burawoy, 1985) leads to autocracy in the labour process. Research finds, however, that work relations are often characterised by tacit negotiation and a degree of give and take. Reasons include: the absence of a Taylorized production process, which means that work is less rationalised and regulated than in some more formal contexts; close personal relations between manager and worker, which make harsh autocracy hard to sustain; and familial and kinship ties that cut across the wage labour relation.

Distinctive adjustment processes within small firms shape the way in which regulations are perceived and mediated. For example, “informality” – in the sense of management-worker relations based informally on unwritten arrangements and tacit understandings (Edwards et al., 2003, p. 20) – can mean that issues relating to pay and working practices are handled without resort to formal administrative procedures. In such a context, firms can be expected to behave in two main ways: to avoid formal procedures in such areas as discipline and dismissal, and more generally to rely on face-to-face understandings with employees. Crucially, such understandings eliminate any explicit statements of rights and duties, with the further implication that legal obligations will be ignored if they do not relate to the established set of informal norms. There were many instances of these informal norms in Ram et al.’s (2001) study of restaurants, with the complex case history of one worker in particular, Baldev, incorporating almost every facet of the paternalistic informal working relationship. Having relinquished self-employment through ill-health, he found himself with nothing to do and so took up a waiter’s job with a restaurateur acquaintance. Typical of many curry house workers, he is prepared to rationalise paltry earnings – £3 per hour with no account taken of volatile working hours depending on how busy it is – in terms of the quid pro quo of intangible benefits. Particularly valued is the absence of rigid work discipline, so that “if I arrive late, the boss doesn’t say anything”. He also enjoys the sociability of the working environment and clearly feels that the boss has done him a favour by liberating him from enforced idleness. Part of this quid pro quo is that he would not consider asserting his legal rights and, though aware of the NMW, commented, “I do not get that […] I work here because I like it […] If I stayed at home, I would not know what to do”.

Baldev’s case also makes the point that the condition of low-paid ethnic minority employees has to be seen, not simply as an isolated workplace phenomenon, but also in an entire context of informal social networks. Such networks are crucial in facilitating access to work and providing a linguistically and culturally familiar environment in the workplace itself. The type of management approach experienced by Baldev was suggestive of the paternalist arrangements widely noted in small businesses in general (Ram, 1994; Wray, 1996), and specifically in ethnic minority firms (Bailey, 1987; Herman, 1979). The flexibility and apparent mutuality implied by such work arrangements is suggestive of a certain “ethnic solidarity” (Zhou, 1992). However, the material substance of informal and personalised work relations should also be noted. For instance, close relationships between owners and workers tend to foster collusion and feelings of mutual inter-dependence between the two parties. When under these circumstances workers themselves are voluntarily relinquishing their own legal entitlements, it is easier to get away with breaches in tax and pay legislation (Bailey, 1987; Herman, 1979).

It is equally important to note that, though informal networks may facilitate employment opportunities, allowing people to draw on and exploit personal relationships and networks of existing informal workers, they can also limit the choices available (Leonard, 1998, pp. 139-140). Work in such circumstances can be riddled with internal equalities and abuses. This in turn often curbs the capacity of informal workers to experience these sources of employment as liberating as they not only are indebted to their employer but also to the friendship and other networks which facilitated their employment (Leonard, 1998, p. 139). The full force of this sense of entrapment was evident from the experiences of a homeworker, interviewed in a recent study of the NMW and small firms. It is worth quoting her experiences at some length (see Box 1).

Conclusions

In this paper, we have shown that many of the misgivings about economic informality expressed by management and entrepreneurship scholars are perhaps overstated to some degree. As suggested earlier it may well be that this stems from a failure to give full weight to the contribution of European scholars like Colin Williams whose output in this field can only be described as voluminous (Williams, 2004, 2006, 2013, 2014). Following from his insights, we have shown how powerful theoretical developments can explain different aspects of informality through the analysis of empirical data: ME enables us to understand the origin of informality as the result of the intersection between the regulatory framework, the market and the firms; while WS proves an appropriate approach to understand the mechanisms that reproduce, contests or semi-complies with informality within the firm.

At this point we should caution that, for all their widespread applicability, the principles outlined here fall short of complete universality and should be taken as for the most part applying to micro-firms in the developed world. In the light of the case studies discussed in this paper, it may be tempting to think of informality as restricted to migrant-origin firms but this is strongly contested by such studies as Jones et al. demonstrating native white British firms to be rather more informal than their South Asian counterparts. Ultimately we may regard work in this field as achieving a valuably broad coverage and it is somewhat regrettable that international scholarship has yet to achieve a similar unified scope. It is difficult to miss the irony of an unprecedentedly inter-connected world, yet one in which two sets of researchers in the same field can be sealed off from one another by the Atlantic Ocean, a mutual isolation which can only act to undermine our attempts to get to the truth about economic informality. In the true spirit of international research, we would like to believe that the proposals outlined above for future progress in this field will be carried out co-operatively, relegating the ocean to its proper status as a mere geographic divide.