Sunday, June 5, 2011

Indonesia's Informal Economy...

In the US we're used to heading to the mall, big-box store, or supermarket to do our shopping. However, commerce takes a different form here in Indonesia and other countries in the "developing" world. Although there are malls and supermarkets here, you're more likely to to business with a small-scale neighborhood enterprises, pushcart vendors, and a variety of service providers that carry their shops on their backs and bicycles. Most of these small businesses are part of the informal economy. The informal economy covers a wide range of economic activity that takes place beyond the reach of government regulations and tax collection (1). Informal employment is generally non-contractual and employment is often based on kinship and social relations. Although this off-the-books type of business has been around for a long time, the term "informal economy" was born from an International Labor Organization (ILO) report on Kenya in 1972. Since that time analysis of the informal sector has grown quite a bit, but the original characteristics are still valid:
  • ease of entry into the market place: there are few or no regulatory barriers in terms of permits and licenses that have to be obtained. Moreover, it doesn't require a lot of money to start up a business.
  • reliance on local resources, including labor and materials
  • family ownership
  • small-scale operations
  • labor intensive activities (2)
  • utilizes skills acquired outside the educational system
  • markets are unregulated and competitive
There are good and bad aspects to the informal economy. On the plus side, the informal economy absorbs people that can't find work in the formal sector, and thus cuts down on unemployment. This is really important in developing countries where rural-to-urban migration swells the population of cities; people moving to Jakarta from the countryside have the opportunity to work in the informal sector until they find their way in the city and land a "regular" job. It also enables people to independently identify and take advantage of opportunities, and in this way it helps develop the entrepreneurial skills of the population. Additionally, the informal sector provides a buffer in harder economic times. This was demonstrated here in Indonesia after the Asian Financial Crisis of 1997-98, when formal jobs declined dramatically. Many people moved over to the informal economy to make ends meet.

However, there are drawbacks as well. Among the largest of these is the inability of the government to collect income taxes from the tens of thousands of small businesses in the informal economy. This means less money to provide public services, such as health and education. Moreover, most informal sector enterprises are beyond the reach of government regulators, so the gado-gado you buy off the street, while cheaper, is not subject to the same health codes and standards that govern restaurants. People working in the informal sector are affected as well; they typically have little or no job security, and regulations governing safety in the workplace are frequently ignored. And most of the positive aspects of the informal sector are negated if the informal sector functions as a final destination for laborers and entrepreneurs, rather than as a temporary "holding tank" until they find opportunities in the formal sector.

You can see the percentages for formal and informal sectors around the world on the map below. I took this from a site called "Mish's Global Economic Trend Analysis". It's the only map I could find without doing some scanning, so sorry about the superfluous notes.

It's traditionally been very difficult to get accurate statistics on the informal economy because of its under-the-table and off-the-record nature. However, it is generally accepted that more than 50% of the workforce in developing countries is employed in the informal sector. In some countries it can be as high as 90%. Compare this to 4-6% in wealthy countries and you have quite a contrast. Estimates for Indonesia are that 70% of the workforce is in the informal sector, with a higher proportion in the countryside compared to the cities (80% to 25%). There is also a gender component here; women are more likely to be engaged in informal employment than men (2:1), and they are also paid less. The large informal sector (and lack of information about it) makes it difficult to create policies to protect workers, provide services, and encourage economic development.

Recently I spent a day chatting with people employed in the informal sector around Jogjakarta. Though they all expressed the same concerns about healthcare, they seemed to appreciate the open nature of the informal economy. The tailor working at the stall in the picture to the right told me that in a day he and his partner make about 50,000 rupiah ($6 or so) which they split. He said he usually sleeps in the stall. He told me there are no regulations governing his business and that they don't pay taxes, so overhead is low. Also the machines they use are pedal-powered, so there is no electrical bill. He said that anyone could start up a business like this one. The drink vendor in the second picture to the right told me that he did a pretty good business because he has a regular clientele. He has two pushcarts; one he operates during the day in a business district, while at night he sells sweet drinks at the Alun-Alun, a large park area south in the Kraton where people congregate in the evening. He told me that it wasn't hard to start up a business, but he did have to be inspected periodically by the health department. He also told me that sometimes there can be fierce competition because so many people move to the city and start small businesses like his.

Household helpers (pembantu rumah) also form a significant part of informal employment here. However, they have different circumstances than the folks described above. In many cases the employer provides lodging and meals for the pembantu, but the pay is significantly lower. However, the employer also assumes some responsibility for the pembantu and has certain obligations, sometimes including providing education and money for the pembantu's family in case of emergency. And while can't state this as fact, it seems to me that there is an expectation that well-off people will employ household helpers, which provides jobs for a significant number of low-skilled people.

Anyway, that's a wrap for today.

(1) Some economists differentiate between the "informal sector" and "informal employment". The first term refers to businesses that are not formally registered with the government, whereas the second term refers to all the people that are employed on a "casual" basis. This includes people working for established companies without contracts and benefits.

(2) "Labor intensive" means that the production process relies more on human labor than machines.


Graph of supply and demand of labor from Food Policy Analysis, 1983 World Bank and Stanford University. Click on the graph and your computer should show it to you against a white background so you can examine it.


  1. Informal Economy seems like a trademark in South East Asia because the Philippines is quite similar to Indonesia's marketplace. There are many small vendors located all over this region, maybe except for the big cities like Manila for example. Informal economies are generally found in developing countries presumably because of its rural and impoverish state. They don't have the necessities and abilities capable of competing like their counterpart shared in the wealthier and more urbanized state. Personally, I would never shop for food in these areas because they're unsanitary, and are not federally regulated with the same health code as their counterpart. However, my mother still like to shop in the smaller marketplaces (i.e China Town) as oppose to Times Super Market or WalMart possibly because it's cheaper.

  2. The informal economy in Indonesia and the degree of intervention by the government seem well balanced and profitable for many local people though it might have slowed the pace of sdevelopment down to some extent. I’m wondering what will happen if one informal business does really well and begins to earn $1000 a month or even more. Will government force them to acknowledge as a “formal business” and have them pay taxes? Or is it really up to the owners?

  3. According to the Indonesia's informal economy from the second paragraph, I can tell it has the same business as china. People carry their product and sell it on the street. I think this kind of business is more flexible and more opportunities than the formal business, because they can sell their product anywhere, especially for the people who want to buy goods but lazy to go to the supermarket.
    Paragraph three shows the good and bad effects of the informal business. Most of the people had a hard time finding jobs according to their education level, background and other personal information. Informal business helps them to develop the own business and give them a chance to earn money and live in this society. However, it also makes them stay in the same level of life, decrease chance of the improvements for better life.
    One of the informal businesses is household helper; it provides a work opportunity for the low-skilled people. They don’t need to pay for the meals and lodge because it was provided by the employer. And when they got emergence for their family, they can always borrow money from the employer. I think it was good because they can find their value in the society and prove that they will be able to live in this society