Opting for Exit: Informalization, Social Policy Discontent, and Lack of Good Governance

Abstract

The informal sector challenges economic growth and hinders the abatement of income disparities in developing countries. This study argues that a weak and poorly governed welfare state can cause the informal sector to increase when individuals use it as an exit option from an unsatisfying welfare system. The article explores how the welfare state’s benefit structure and citizens’ trust in institutions to deliver public goods affect the likelihood of informality. A logistic hierarchical model, based on cross-sectional survey data from Latin America and the Caribbean and descriptive panel data from Brazil, is used to test the hypothesis. Findings reveal that social policy discontent, low trust, an elitist distribution of welfare benefits, and dysfunctional institutions increase the likelihood of being informally employed. However, workers with greater agency—the better-educated—seem notably less likely to informalize when social policy benefits are targeted toward their own socioeconomic group.

Fairness and Tax Morale in Developing Countries

“…Understanding the "fairness side" of reciprocity is critical to the literature on the micro-foundations of tax and transfer systems in developing countries. As correctly argued by several scholars, the characteristics of the labor market (e.g., the size of informality), the recent evolution of the welfare system, or the scope of redistribution shape people's expectations about the fiscal contract (Timmons 2005;Carnes and Mares 2014;Timmons and Garfias 2015;Holland and Schneider 2017;Holland 2018;Berens 2020). Holland (2018), for example, presents suggestive evidence that poor people in Latin America have diminished expectations about what the state can provide and redistribute.…”

“…On the other hand, labor informality restricts governments' ability to promote tax progressivity because many workers are effectively excluded from social protection systems, and it is difficult to catch them in payroll or income tax nets (Castañeda and Doyle 2019;Berens 2020). Also, access to social insurance is expensive for informal workers, and the coverage of non-contributory social insurance programs remains limited (Mesa-Lago 2008; Franzoni and Sánchez-Ancochea 2016; Cruz-Martínez 2019).…”

“…Also, access to social insurance is expensive for informal workers, and the coverage of non-contributory social insurance programs remains limited (Mesa-Lago 2008; Franzoni and Sánchez-Ancochea 2016; Cruz-Martínez 2019). The high degree of fragmentation of the labor market also creates strong incentives for individuals to opt out of fragile public welfare systems (Berens 2020). There is also evidence that differences in employment status affect policy preferences (Carnes and Mares 2014), constrain their electoral demands for redistribution (Holland 2018), and ultimately shape public attitudes toward progressive taxation (Berens and Gelepithis 2018).…”

Labor Informality and Economic Political Accountability of Executive Incumbents in Latin America

“…Future works could test the proposed mechanisms. This work importantly contributes to the small but expanding literature that seeks to identify how labor informality affects individuals' political preferences, attitudes, and behaviors in Latin America (Altamirano, 2019;Baker & Velasco-Guachalla, 2018;Berens, 2015Berens, , 2020Berens & Kemmerling, 2019). However, future efforts are vital.…”

Does clientelism hinder progressive social policy in Latin America?

“…When social policy supply does not meet citizen's expectations, the willingness to opt-out of fiscal contracts [e.g. entering the informal economy (Berens 2020)] increases.…”