Peru | Labor informality and some proposals to reduce it

Labor informality negatively affects economic growth, the productivity of workers and social welfare (it makes access to credit difficult and, by reducing tax collection, induces lower coverage and quality in the provision of public goods and services). In Peru, yes Although labor informality has moderated in the last ten years in a context of greater economic dynamism, still remains at high levels, which suggests that it is necessary to take actions to reduce it and limit its harmful effects. In general, it is necessary to improve the regulations under which the labor market operates in Peru to correct the elements that inhibit formal contracting. It is also necessary to strengthen labor inspection and raise the worker productivity. This document contains some concrete proposals for attack the problem of labor informality, developed with information collected in interviews specialists in the subject. Its eventual implementation will require consensus building, for which must adequately communicate the benefits that can be obtained for millions of people who are currently working in precarious conditions.

How is labor informality defined and what are the causes? what generates it?

Broadly, the informal sector of the economy encompasses individuals, businesses, and transactions that are carried out outside the legal regulations and tax obligations established to regulate the economic activity.

. From a labor perspective, informality implies the establishment of relationships that do not fully or partially comply with current regulations.

. For example, this situation occurs when a company fails to comply with the legal obligations it has towards its workers, such as such as the payment of a salary equal to or greater than the minimum, the contributions that must be made for the schemes of protection against unemployment, payments to social security and the pension system, vacations, among others.

How much informal employment is there in Peru and how does it compare to other countries?

More than two thirds of the workers are informal in Peru (see Graph 1). It is true that there has been a significant reduction in the proportion of jobs with these conditions, but the informality rate continues to be high (around 71%), which implies that more than 7.5 million people work in informal conditions. The rate of labor informality does not compare well with what happens in the rest of Latin America (see Chart 2).

Now, it is reasonable to think of a limited rate of labor informality in a country where, for example, there is an adequate institutional framework, laws are followed, justice is fast and predictable, it is easy to do business, capital capacities Human resources are high, the state provides goods and services adequately, and the size of the agricultural and rural population is relatively small. Does Peru have these characteristics? If you do not have them, what is the informality rate consistent with your particular characteristics? To answer this question, we synthesize the aforementioned characteristics in a simple indicator: per capita GDP. Then, based on information from the World Bank and the International Monetary Fund on the labor informality rate and per capita GDP (measured in terms of purchasing power parity) for different countries, we found a relationship between both variables (see Graph 3). . For reference purposes, this relationship suggests that a country with the characteristics of Peru should have labor informality of around 40%. Therefore, not only is labor informality high in absolute terms, but it also appears to be higher than in other countries with similar characteristics.

Why is it preferable that formal jobs be created instead of informal?

Labor informality has pernicious effects on economic growth and the well-being of people. These effects occur due to:

 a. Reduced worker productivity. The idea here is that informal workers, who work in informal companies, carry out their activities in precarious conditions and with low equipment, which affects its performance. In other words, two identical workers (with the same capacities, education and skills) and who carry out the same activity have different performance depending on the working conditions found in your workplace.

On this point, it should be noted that data recently published by the National Institute of Statistics and Information Technology (INEI) suggest that the average productivity (and with it the average income) of a worker employed in a formal productive unit is almost four times greater than that of a worker employed in an informal productive unit (see Graph 4)4

Although part of this difference is explained because workers with more education tend to be employed in the formal sector (see Figure 5), a characteristic that naturally makes them more productive, another part of the explanation may be linked to the practices and conditions in which that often operate informal production units. INEI surveys show that informal productive units tend to operate without accounting records (or when they do, consist of personal notes), often do not have a location (or when they do, it is usually one of the rooms of the house and this room is not only dedicated to business), and they generally have limited exclusive access to public services such as wáter drinking water, drainage, electricity, fixed telephone, or internet (see Graph 6). In other words, the units Informal productive companies do not have the best practices or conditions to operate a business, which negatively affects the productivity of the workers employed there (and thus their income) regardless of their educational level.

b. The distortion in the allocation of resources. If, due to excessively rigid legislation of the labor market, formal companies consider that it is very difficult to hire employees, it is posible that they may opt for a more intensive use of resources that are not affected by the regulations.

In this case, formal companies oppose a less than optimal level of labor, given the availability of workers in the economy, and would eventually replace them with a more intensive in capital goods, for example.

c. A lower tax collection that affects the provision of public goods and services and generates a tax burden on the formal sector. As a result, the productivity and competitiveness of formal companies, and the economy in general, is reduced. Because informal workers do not pay direct taxes (income tax, which is the more relevant, although, eventually, they pay indirect taxes such as the one applied to the sales), state revenues are diminished. This situation limits the coverage and quality of the goods and services provided by the State (education, health, justice, citizen security, infrastructure). In particular, the informal sector (workers and companies) makes use of and can congest public infrastructure, but does not contribute to improve and maintain it. As the Infrastructure is part of the productive process, its congestion by the informal sector affects the productivity and competitiveness of the economy.

The low tax collection that can be associated with a large informal sector creates another problem. To compensate for the lower tax revenues and to be able to finance their activities, the State relies only on the collection obtained from the formal sector (workers and companies), overloading it with taxes, often distorting, which remains competitiveness to formal activities and the economy in general.

d. A more limited access to credit. A worker employed in informal conditions has more difficulties in sustaining a sustained flow of income (a situation that differs from that faced by a formal worker who appears on the payroll of a company). In this context, the evaluation of risks posed by the lending financial entity is complicated and, therefore, the granting of the credit for the informal worker (see Graph 7). As a result, people who do activities in the informal sector (and those who depend on it) have more limited capacity to invest in themselves (for example, in training and education that later generate more income) and are also more exposed to fluctuations in their income (due to an illness, for example).

e. The absence of the social protection provided by formal employment (in terms of protection against unemployment and health, for example), which reduces the well-being of people who work in the informality.

                 BBVA.( 2017, jan 9th). Peru | Labor informality and some proposals to reduce it.      Observatorio económico del Perú. https://www.bbvaresearch.com/wp-content/uploads/2017/01/Observatorio-informalidad-laboral1.