Uploaded by Ben Morehead, Associate Publisher of Policy Review magazine and authorized agent for the copyright owner(s). NOTES FROM THE UNDERGROUND America's Sprawling Informal Economy by Jeffrey R. Tucker From the Summer 1993 issue of Policy Review To subscribe to Policy Review, call (800) 544-4843 Government policies usually have unintended consequences, but one effect is literally invisible to policy-makers. When regulations get too complex or costly, or taxes too high, employers, workers, and entrepreneurs sometimes move outside the official system and into what is called the "informal sector." A growing body of research suggests that the informal sector -- also called the underground, unofficial, black, subterranean, or non-registered economy -- is an extremely large and highly productive subsection of the economy. In it mostly legal goods and services are bought and sold in a manner that evades the government's regulatory and fiscal reach. During the presidential transition, public attention focused on the off-the-books hiring of nannies, sometimes illegal immigrants. The Zo‰ Baird phenomenon is but a small part of a vast subterranean economy that has grown in response to overly burdensome and arbitrary government. The informal sector has been studied extensively by professors of anthropology, urban planning, and sociology, whose political sympathies lie with the Left. Nevertheless, their studies highlight a question that should be of interest across the ideological spectrum: Isn't something wrong when an entire segment of the population works extremely hard, possesses valuable skills, and produces goods and services people want and use, yet is shut out of the official economy? Shouldn't their activities be considered legitimate? New York Off the Books Professor Saskia Sassen-Koob, who teaches architectural planning at Columbia University, has studied New York City's informal sector for well over 10 years. She thinks American culture places too much emphasis on what she calls "valorized" occupations -- those with a high degree of visibility to match their high wage levels. Professor Sassen-Koob and her graduate students are doing hands-on work interviewing informal street vendors, car repairmen, cab drivers, and others employed in the informal economy all over New York. The researchers have found substantial informal activity throughout the apparel industry, general construction, masonry, stonework, plastering, toys, sporting goods, and electronics. They found unlicensed or unregistered work in most of the 40 standard industrial classification sectors they examined. Concentrating mainly on new immigrant communities in New York, they found an extremely diversified informal economy among Hispanic, Chinese, Koreans, and Russian immigrants in Brighton Beach. In many areas of Queens (Jackson Heights, Ridgewood, and Astoria) and in Brooklyn (Sunset Park and Williamsburgh), skilled cabinetmakers produce customized furniture for a high-income clientele and basic furniture for lower-income residents. Many of the furniture shops are located on the second floor of buildings, since the first floors must adhere to enforced zoning codes, making them available only for other uses. Professor Sassen-Koob and her researchers estimate that in one four-block survey in Manhattan, 90 percent of all interior work was done without required permits and licenses. In government-funded projects, on the other hand, the official sector dominates. But in those public sector projects using subcontractors, growing numbers of informal workers are involved, as indicated by the increased number of labor violations recorded by the Department of Buildings. These are the "fly-by-night" operations often denounced in the press. Sometimes it takes an accident and follow-up investigation to reveal informality. One such case occurred in the early 1980s when a crane operator dropped a block of cement and nearly crushed a passerby. The newspapers were outraged to discover that he was unlicensed, and a follow-up showed an unexpectedly high incidence of people working without licenses. Clothing is one of the most important informal industries. Professor Sassen-Koob has discovered that most production workers in the apparel industry in New York and New Jersey do unregistered work in "sweatshops" and at home and sell their product to registered New York firms. These sweatshops are located Chinatown and throughout Manhattan, and in Brooklyn, Queens, and suburban New Jersey. And although New York's official footwear industry has been in decline for a decade, at least 10 percent of the industry has gone informal, with spinoffs in handbags and other leather goods. Some types of informal work pay well. For example, freelance designers often convert their lofts in lower Manhattan, hire immigrant workers to come to their homes, and work completely off the books. In other cases, middle-class women do finishing work on expensive garments with special equipment that the women buy themselves. Large electronic firms that employ union labor have been on the decline for some time in New York. They are being replaced by informal arrangements of contractors working out of the garages and basements in middle-class residential neighborhoods. Not only is this more convenient for the workers themselves, they offer, according to Professor Sassen-Koob, "greater efficiency, quality, and speed." Transportation services may be the largest source of informal employment in New York. Professor Sassen-Koob reports that "there are now twice as many gypsy cabs as there are licensed taxi cabs." The huge number of informal vans form a network that makes up a mass transportation system. The official system doesn't serve as many areas, is not as safe, and sometimes requires several transfers. The informal system gets around all these problems, as well as offering air conditioning and pleasant music. Hundreds of auto-repair shops and body shops have sprung up in immigrant neighborhoods. One shop in Brooklyn handles 100 cars per day, far exceeding local demand, and suggesting that people come from all over the city to purchase informal car-repair services. As would be expected, the incidence of informality in New York tends to be higher in industries that have a heavier tax burden and higher unemployment rate. The heavier the burden of outside intervention, the more the incentive to escape. It is the main reason high-price informal jewelry and fur shops have sprung up. Consumers like the high quality, low prices, and convenience, and producers have much greater flexibility in adjusting to consumer taste. There are no legal barriers to entry, which allows fast entry and exit. Miami Vice Miami is no less a haven for informalism. Professor Alex Stepick, of the University of Miami, has studied this area closely, especially with regard to Haitian immigration. He believes that racism locks Haitians out of the official economic system. His concern led him to look more closely at the Haitian and Cuban immigrants' primary source of work and income. Overwhelmingly it is the informal sector that plays a large role in incorporating new arrivals into the division of labor. About one-third of new Cuban immigrants in the early 1980s worked in the informal sector. As in New York, the labor code is one of the main reasons businesses and their employees go underground. Laws that mandate age requirements, work hours, and minimum wage have no relevance for people who are trying to provide for their families and can do so by working hard. These people will gladly take jobs, even if the hiring and firing is done outside the law. In the early 1980s, many large formal firms that employed union workers went out of business. But the formal firms employing informal workers, and the other firms that are completely underground, survived, and even grew. When the U.S. Department of Labor ran a sting operation against Miami's garment industry, they found labor-law violations in 132 firms and mandated back pay to 5,000 workers. According to Stepick, Miami unions did not accept Cuban members until the mid-1970s, which led the Cubans to create their own firms, with separate labor markets, and to compete for housing contracts on a cash-only basis. When the 1973 recession hurt the formal firms, the informal firms in the garment industry paid less in wages, but managed to survive the recession. Racism was less of a problem in the restaurant business in the early days of immigration, says Stepick, but Haitians and Cubans worked out of sight of the customers cooking and washing dishes. It is only because restaurants violated health, safety, and labor codes that they could employ so many. Today, many of the same workers own their own informal firms in immigrant neighborhoods. So regulated is our nation's child-care industry that it is not surprising that informal provision has exploded. Stepick argues that the houses spilling over with children in Miami's Little Haiti are daycare operations, charging $2 to $5 per day. Most of their clients are poor and could not afford what he calls "state-sanctioned" care. If the informals were shut down, there would be nowhere to put the children. Mom and Apple Pie The growth of the informal economy in cities like New York and Miami is partly linked to the growth of illegal immigration. But informalism is widespread as well in neighborhoods without many immigrants. The informal economy is as American as mom and apple pie. Professor Michele Hoyman of the University of Missouri, St. Louis, has studied the informal economy extensively. As a feminist political scientist, her main interest is in the areas of sexual harassment and anti-discrimination laws. Professor Hoyman's research shows that many occupations nearly entirely dominated by women have very high rates of informality. For example, 84 percent of child-care workers not in private homes, and 50 percent in private homes, pay no social security tax. Similarly, 25 percent of hairdressers and cosmetologists and 50 percent of registered nurses do not pay. At least one million American women operate businesses out of their homes. This evidence indicates that the informal sector is particularly attractive to women, but probably not because of systemic sexism in official markets, as Professor Hoyman would argue. It is because, on the whole, women are more likely to find employment in the "non-valorized" occupations that thrive in the informal sector, occupations that do not require extensive capital investment, large start-up costs, and intensive training or experience. In reality, official firms always will be less likely to hire women than men, or pay them as well, because of the costs indirectly imposed on employers by childbirth and childrearing. The informal sector simply accommodates the scheduling demands of women better than licensed, salaried, official employment does. In addition, official business is increasingly saddled with the requirements of mandated benefits like family leave, the costs of hiring women will continue to grow, which in turn pushes them out of formal and into informal work. Everyone a Lawbreaker The informal economy is as capitalistic as the formal economy, for it involves entrepreneurship, trade, saving, working, wages, and capital, as in the formal economy. Moreover, the existence of the informal sector should be seen as a failing of government, not the market. Regulation drives people outside the official economy. Today, nearly every industry and service, every profession, and every dollar earned are subject to some dictate from Washington. The labor code mandates that only people of a certain age can work ("child" labor laws) and that people of low marginal product cannot ("minimum wage"). Laws mandate that businesses provide a myriad of benefits to employees that are often prohibitively expensive. State and local governments have their own regulations, from zoning ordinances to rental restrictions. These interventions create conditions that sometimes make going informal more attractive than staying official. If, for example, you buy a cheesecake your neighbor baked in her kitchen, you are probably engaging in an illegal act, depending on local and state laws. There are health and equipment regulations, and specifications for the kitchen's size. The effect is to create a monopoly for restaurants, but it is also to criminalize what seems to be a perfectly natural economic arrangement. If a family rents a room to a student, even though the area is zoned to prohibit rental use, the family becomes informal. When parents employ their underage children in the family, they break the law and qualify as informal. The same is true for the informal handyman who has no office or license. When the photographer gives a free photo session to the family of an auto body shop owner, and the quid pro quo is a repainted car, they enter the informal sector. Babysitting services, cab services, yard sales, and fruit stands are all part of the informal market. Encouraging Informality Informal business activities have common features. Labor is undeclared, and workers receive few if any of the "social benefits" found in the formal sector: unemployment insurance, health insurance, union organization, and minimum wage. Work conditions do not meet official health and safety standards. The firm's location usually falls outside normal zoning laws. Management is not bound by official standards of accounting and reporting. Many informal firms rely on cash, payment-in-kind, or bartering as methods of payment. They cannot advertise openly. Informal sectors are not found only in cities. A study by James D. Smith, of the Survey Research Center of the University of Michigan, found that in one year, four out of five consumers purchased something from a producer in the informal sector. Consumers bought a wide variety of goods and services, from a sandwich at a street vendor's cart to building repairs on their homes or businesses. In fact, the largest sources of informalism are in the areas of home repair and food preparation. Mr. Smith estimates that as many as 15 percent of American workers are involved in some type of informalism. Informal activity may account for between 5 to 33 percent of the U.S. Gross National Product. Prostitution and illegal drugs, of course, are important markets in the informal economy. The overwhelming majority of informal activity, however, does not come from producing and selling illegal goods and services, but from producing and selling goods and services in a manner made illegal by government-created barriers. When the costs of obeying tax and regulatory rules become too high, people will find ways to improve their standard of living outside of approved channels. When the child-care industry is regulated, for example, informals inevitably appear the next day. The more overbearing the mandated benefits on business become -- as in health insurance, child care provision, and unemployment payments -- the more tempting it is for entrepreneurs to decentralize and informalize. High taxes increase the benefits, and thus the prevalence, of going underground. And tax increases can cause shifts from occupations that require withholding taxes to those in which income reporting is subject to more discretion -- a shift from firm-based employment to self-employment is one example. If governments fail to change their legal structures to accommodate informals, and regulatory trends in this country continue -- if the economy becomes less and less capitalistic -- the informal sector will expand beyond its current scope. The growing informal economy is a testament to the resilience and ingenuity of people when confronted with governments that want to manage their economic life -- and a reminder that total economic control will always be beyond government's reach. JEFFREY R. TUCKER, a fellow of the Ludwig von Mises Institute, is associate editor of the Austrian Economics Newsletter and editor of the Free Market. 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