Difference between FORMAL and INFORMAL economy

Economy and Finance

Difference between FORMAL and INFORMAL economy

30 Sep 2023 Zinkpot 192

The formal economy and the informal economy are two distinct sectors of an economy that differ in various ways, including their characteristics, activities, regulation, and impact. Here are the key differences between the formal and informal economy:
Definition and Characteristics:
- Formal Economy: The formal economy refers to economic activities and transactions that are officially recognized, regulated, and monitored by the government. These activities typically operate within the legal framework and are subject to taxation, labor laws, and other regulations.
- Formal sector jobs often come with legal protections, such as minimum wage laws and employment benefits. Examples include jobs in large corporations, government agencies, and registered businesses.
- Informal Economy: The informal economy encompasses economic activities and transactions that are not officially recognized or regulated by the government. These activities often occur outside of the legal framework and can include street vending, unregistered small businesses, day labor, and cash-in-hand work.
- Participants in the informal economy may not have access to legal protections, social security, or other benefits associated with formal employment.
Regulation and Taxation:
- Formal Economy: The formal economy is subject to government regulation and taxation. Businesses and individuals engaged in formal sector activities are required to adhere to tax laws, labor laws, and other regulations. They contribute to government revenues through taxes, and their activities are tracked and monitored.
- Informal Economy: The informal economy operates largely under the radar of government authorities. Many participants in the informal sector may not pay taxes or adhere to labor regulations. This can result in lost tax revenue for the government and can make it challenging to enforce labor standards and protect workers' rights.
Job Security and Benefits:
- Formal Economy: Workers in the formal economy often have greater job security and access to employment benefits such as health insurance, retirement plans, paid leave, and legal protections against unfair labor practices. Formal sector jobs tend to be more stable.
- Informal Economy: Workers in the informal economy typically have less job security and may lack access to benefits and legal protections. They often work in more precarious conditions and may be vulnerable to exploitation.
Economic Impact:
- Formal Economy: The formal economy contributes directly to a country's Gross Domestic Product (GDP) and provides a stable source of revenue for the government. It is easier for the government to implement economic policies and social programs when economic activities are conducted within the formal sector.
- Informal Economy: The informal economy, while often contributing to economic activity, may not be captured in official GDP figures. It can be less stable and more susceptible to economic shocks. However, it can also provide livelihoods for individuals who may have limited access to formal employment opportunities.
It's important to note that the informal economy is not inherently negative; it often arises due to economic necessity and lack of formal job opportunities.
Policymakers often strive to bring informal economic activities into the formal sector to improve labor conditions, increase tax revenues, and provide workers with legal protections.