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NOTES FROM THE UNDERGROUND
America's Sprawling Informal Economy
by Jeffrey R. Tucker
From the Summer 1993 issue of Policy Review
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     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 Zoë 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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