Why Informal Economies can Become Larger than Illegal Economies

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Elwin Poortman
Analyst, Netherlands

Why Informal Economies can Become Larger than Illegal Economies

Over the last decades, the concept "informal economy" has been conceptualized in many ways (see here for detailed info); scholars often refer to it as economic activities that take place outside a defined legal framework. This easily makes one assume that informal behavior is synonymous to illegal behavior.

Webb, Tihanyi, Ireland, & Sirmon (2008) do not agree with this reasoning and distinguish a difference between informality and illegality. In order to prove this, they refer to the concept of LEGITIMACY, best defined as: “a generalized perception or assumption that the action of an entity are desirable, proper or appropriate within some socially constructed system of norms, values, beliefs and definitions”.

This construct legitimacy is centered around public acceptance. The authors underline that formality and informality are affected by the concept of legitimacy. They argue that society's acceptation (legitimization) of informal entrepreneurship suggests that informality is not seen as something illegal by society. This means that there is a gap between what is illegal by law and what is illegal (or illegitimate) according to society.

In order to clarify this distinction, the authors underline differences in the so-called INSTITUTIONAL FRAMEWORK:
  • Formal institutions refer to laws, regulations and the supporting apparatus such as law enforcement. These institutions define the regulatory framework which divides legality from illegality.
  • informal institutions refer to norms, values and beliefs that define socially acceptable behavior, or in order words, it separates legitimacy from illegitimacy
Some activities are both illegal and illegitimate in that they take place outside the scope of both formal and informal institutions. Human trafficking or drug cartels are a clear example of this.

The distinction between legitimacy and legality is used to explain why informality is not equal to illegality; the authors reason that informality is prohibited according to formal institutions but it is legitimized by informal institutions, whereas illegality is categorized as activities that take place outside the legal framework (illegal by law) and are not accepted by society (illegitimate).

This distinction enables one to understand why informal economies can become much larger than illegal economies. It also explains why the combat against the growth of informal economies can be rather hard or even futile, since its activities are accepted by (a large part of) society.

Source: Webb, Tihanyi, Ireland, & Sirmon (2008) You say illegal, I say legitimate: Entrepreneurship in the informal economy, Academy of Management Review 2009, Vol. 34, No. 3, 492–510.


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