Fostering Corporate Sustainability Through Formalization

Introduction

An informal economy is defined as one in which economic activity is developed without compliance with the laws and administrative rules that govern property rights, the granting of commercial licenses, work contracts, financial loans, and social security systems.

High levels of informality in a country bring about high costs that limit the ability of firms to be profitable and though be sustainable.

Some of the costs associated with high levels of informality are:

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  High government expenditure needed to provide social programs to provide for social services that would otherwise be covered by a formal system. As is widely documented, this expenditure brings about distortions to the economy such as higher interest rates, which crowds out the private sector’s investment, appreciate the local currency, and brings about the need to increase taxes and public debt.

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  High tax tariffs for a reduced number of formal firms and individuals. These tariffs depress the economy and foster tax evasion and the migration of companies to informality, creating therefore a vicious circle by which informality is reinforced.

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  The social and economic statistics in a country with high levels of informal economy lose reliability since they do not include or have just estimate values of those enterprises/workers that do not declare income.

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  Other costs relate to high levels of employee turnover. Firms that hire informal workers are not subject to the regulation that protects workers from being fired without a fair cause. Hence, employers will be more prone to dismiss workers at higher rates. Besides, by not being paid by a formal payroll, informal workers find more difficulties when trying to obtain credits at formal financial institutions.

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  Furthermore, informal firms are characterized by experiencing low levels of productivity, caused by limited of access to formal financing instruments, and training programs, that would, otherwise, enable companies to obtain the knowledge and technology needed to increase their levels of productivity.

Accordingly, reducing the levels of informality must be in the top list of priorities of any country that aims at reducing its levels of poverty, and transition into a path of economic development that allows for a significant improvement of the well-being of its population.

Given the framework described above, the chapter's objective is to identify the actions that Colombia can implement to effectively reduce its levels of informality.

This identification serves to guide both the private and public policies in establishing a roadmap for solving one of the main obstacles to development faced by Colombia. Furthermore, the lessons serve as a model that can be implemented beyond the scope of the Colombian economy and therefore can be applied by other emerging countries elsewhere.

To achieve this goal, the chapter is organized in four sections. The first one begins with a literature review that present the main theories and concepts related to the phenomena of informality. Afterwards, the chapter presents a statistical outlook on the characteristics of informality around the world that finishes on a deeper look on the situation for Colombia. Then, the chapter presents measures that Colombia has taken to reduce its levels of informality. Finally, the chapter begins the discussion on the measures Colombia can take to reduce the levels of informality.