Living with Informality: What the Current Debates Mean for Practitioners

A couple of years ago I wrote about the drive to formalise the informal economy in Solomon Islands, based on work with government and its partners on a national action plan to support informal enterprises transition towards sustainable growth and formalisation. That piece argued that informality is not mainly a compliance problem but a core part of how people earn a living. Formalisation should offer pathways, not punishment.

Since then, the global debate has moved on. The question is no longer whether formalisation is desirable. It is: what kind of formality, for whom, and in whose interest?

A tougher macro context

The 2026 macro context sharpens these questions. Growth is weak, debt stress has increased, and energy and transport costs remain high for many developing economies. UNCTAD’s 2026 outlook describes a global economy dealing with overlapping geopolitical and financial shocks. In that setting, “register-and-tax” looks attractive to finance ministries under pressure to raise revenue. But, for low-margin businesses, especially informal ones, extra compliance costs can be the difference between survival and closure. ICTD argues for a better understanding of the local landscape of informal revenue generation in order to avoid adding new burdens on particularly vulnerable or already over-taxed groups, as well as the relationships of local authority and power that underpin them.

This tension is not new, but it is more visible. Is formalisation mainly a fiscal and control tool, or part of a wider effort to support productivity, decent work and basic security? Different parts of government answer this differently. So do different donor and development agencies.

What problem are we trying to solve?

A first question I now ask more directly is simple: what problem is formalisation meant to solve here?

Recent research, including a 2026 study of the baobab sector in Malawi, reinforces what many of us see in practice. Most informal firms are opting out of formality because the cost of entry is high, the benefits are uncertain, markets are thin and state capability is limited. For many, informality is a rational response to risk and constraint.

In the DCED paper I co‑authored on dealing with firm informality, we came to a similar conclusion: informality is better seen as a symptom of deeper problems—low productivity, limited access to finance and skills, weak contract enforcement—than as a stand‑alone governance issue. That has implications. If the underlying problem is low productivity and insecurity, registering firms without changing those conditions will do little good and may do harm.

Across agencies, I see two broad camps. One focuses on making firms offfical – getting them “on the books” – to support domestic resource mobilisation and strengthen the rule of law. The other treats formalisation as a possible outcome of broader investments in productivity, social protection and administrative capacity. My bias is toward the second, but the trade‑offs are real, and our advice needs to acknowledge them.

One-size-fits-all reforms are running out of road

A second debate is about method. Over the past two decades, many programmes have backed standardised reforms: simplified registration, one‑stop shops, flat‑rate tax regimes, and indicator‑driven reform agendas. Some of this has helped, but the evidence is mixed. In many countries, we see easier procedures on paper but only modest shifts in how firms actually operate.

The Malawi baobab study is one of several pieces suggesting that effective strategies need to be sector‑specific, place‑specific and co‑designed with entrepreneurs. This is consistent with what I've seen in other settings: generic reforms rarely reach the smallest firms unless they are tied to concrete changes in how those firms access markets, finance and services.

This creates a challenge for governments and the donor and development agencies that support them. It is easier to report on “number of procedures reduced” or “number of firms registered” than to track more complex outcomes such as changes in productivity, earnings or resilience in a particular value chain. But if we stay with the easy metrics, we risk focusing on what we can count rather than what matters.

Getting the sequence wrong can backfire

Sequencing remains contested. Some argue for early formalisation to widen the tax base, enforce standards and link firms to value chains. Others warn that pushing firms into compliance before they have reasonable productivity and market access can reduce welfare, not improve it. It may simply produce “paper formality”: registered firms that still rely on informal labour practices, or that fragment to stay below thresholds. I did laugh when I heard this described as "formalisation fetishism" - where “formalisation” is treated as a single, inherently good object, detached from underlying social relations and outcomes.

ILO Recommendation 204 and its related guidance has helped anchor a more gradual approach to formalisation. Many agencies now talk about three steps: extend basic rights and social protection to informal workers and micro and small enterprises; lower the cost and complexity of formality; and then improve enforcement. In practice, fiscal pressures pull the other way. In several countries I work in, tax and treasury agencies push for faster registration and enforcement, while social and SME‑development counterparts argue for more patience. Private sector development practitioners and business environment reformers often need to make these tensions explicit and help find workable compromises.

Digital formalisation is not neutral

Digital tools have added a new dimension to this. E‑ID systems, e‑invoicing, mobile tax filing and platform‑based marketplaces are often sold as ways to “formalise by default” and cut transaction costs. In my DCED study on business environment reform and digital transformation, I found real gains where connectivity, trust and basic capabilities were in place—but also saw risks of exclusion where they were not.

For low‑literacy, low‑connectivity, women‑owned and rural firms, digital formalisation can raise new barriers and expose them to scrutiny without improving their access to services or finance. At the same time, AI‑driven analytics are giving tax and regulatory authorities new tools to profile and target firms.

While AI offers powerful tools to expand registration and improve risk‑based enforcement, there is a real danger that these capabilities are used primarily to “tighten the net”: to deepen surveillance, expand taxpayer rolls and automate penalties for non‑compliance among easily visible micro‑enterprises. Donor‑supported reforms should instead embed AI within a broader, negotiated package that raises productivity, reduces compliance costs and strengthens the bargaining power and voice of small firms and informal‑worker organisations, before demanding more of them in terms of taxes, data disclosure and regulatory obligations.

For me, the practical question is less “digital or not?” It is more about what safeguards, incentives and support are needed to ensure that digital systems do not simply extend surveillance, but also extend benefits—credit, insurance, dispute resolution—to informal and micro firms?

Politics: whose formality?

The political economy of formalisation is now more openly discussed. This is healthy. Registration and licensing change who can operate, who is visible to the state, and who can claim voice. In fragile and conflict‑affected settings, they can be used to exclude rivals or extract rents. In other contexts, they can open space for informal workers to organise and negotiate.

Programmes that focus on “simplification” and “capacity building” sometimes shy away from these questions. Increasingly, funders and business and worker organisations are asking them to show how they engage with the underlying settlement: which groups stand to gain, which may lose, and how informal workers and micro‑entrepreneurs are involved in shaping the rules.

In Solomon Islands, for example, counterparts were clear that they did not want aggressive enforcement against small informal traders who provide a de facto safety net. They were interested in building fair and predictable pathways to formality for those who wanted to grow. That sort of clarity is helpful. It also has to be negotiated politically, not just drafted in an action plan.

A few practical implications

Across these debates, a few practical implications for business environment and private sector development work seem to be emerging:

• Be clear on the problem. Before proposing formalisation measures, clarify whether the binding constraint is really low registration, or low productivity, weak demand, lack of finance, fragile rights, or poor administration. The drivers of informality are often a mix, and formalisation is a downstream symptom rather than an upstream cause.
• Design for coexistence. Informal and formal activity will coexist for a long time. Strategies should aim to reduce the worst forms of informality—those with high risk and no protection—while supporting viable informal activities and opening realistic routes into more formal arrangements where that makes sense. Extending social protection to informal firms and their workers remains a necessary priority.
• Tie formality to benefits. Registration should be visibly linked to access to markets, finance, public contracts or social protection, not only to new obligations. Otherwise, staying informal will remain the rational choice for many.
• Invest behind the front door. Portals and systems matter, but so do local administrations, inspectorates, dispute‑resolution mechanisms and social protection systems that can support, rather than punish, firms that try to formalise. This “enabling environment behind the enabling environment” often needs more attention than it gets.
• Adjust metrics. Counting registered firms or procedures cut is not enough. Where possible, we should be tracking changes in productivity, earnings, job quality and resilience at firm and worker level, even if that is harder and slower.

None of this replaces grounded analysis with governments, business associations and worker organisations. It does, however, give us a stronger set of questions to bring into those conversations.