Why Formalization Alone May Not Solve Developing Countries’ Jobs Crisis

The World Bank’s Rationalizing Informality argues that informality is not always a sign of exclusion, as many workers voluntarily choose informal jobs for flexibility, independence, and better work-life balance. The report urges policymakers to move beyond formalization drives and instead focus on skills development, productive firms, and universal social protection to create better jobs and foster long-term growth.

A new World Bank report, Rationalizing Informality: Social Protection, Job Quality, and Growth, is challenging one of the most common assumptions in development policy: that informal workers are trapped in low-quality jobs because they cannot find formal employment. Produced by researchers from the World Bank with contributions from experts affiliated with institutions such as Carnegie Mellon University, the University of Chicago, the University of Michigan, Paris School of Economics, Columbia University, the London School of Economics, and the Inter-American Development Bank, the study argues that the reality is far more complex.

Across Latin America and the Caribbean, around 55 percent of workers are employed informally. Similar patterns exist across Africa and parts of Asia. Yet despite years of reforms aimed at encouraging formal employment, informality remains stubbornly high. The report suggests that this is because policymakers may have misunderstood why workers choose informal jobs in the first place.

Many Workers Choose Informality

The study finds that informal employment is not always a last resort. Many self-employed workers actively choose it because it offers flexibility, independence, and control over working hours. Surveys across several countries show that workers often value these benefits as much as, or even more than, higher wages.

For many people, especially parents and caregivers, the ability to decide when and how they work can be more attractive than a formal job with fixed schedules. The report estimates that workers place a surprisingly high value on these non-financial benefits, helping explain why many remain in informal work even when formal opportunities exist.

This finding has major implications for policymakers. It suggests that creating more formal jobs alone may not be enough. Governments may also need to encourage more flexible forms of formal employment that better match workers' preferences.

The Microbusiness Reality

Most informal workers are connected to very small businesses, often with five or fewer employees. These microenterprises form the core of the informal economy.

A key finding of the report is that most of these businesses are not trying to become large companies. Their owners rarely seek loans, have limited plans to expand, and are often satisfied operating on a small scale. Many enter self-employment to earn a living while maintaining independence rather than to build a fast-growing enterprise.

This challenges a long-standing policy approach that focuses heavily on business registration and formalization. According to the report, formalizing a small business does not automatically make it more productive or create more jobs. For many microenterprises, the main constraint is not legal status but limited growth ambitions and managerial capacity.

As a result, governments may achieve better results by supporting high-potential entrepreneurs who have the ability to expand, innovate, and create employment at scale.

Why Skills Matter More Than Formalization

One of the report's strongest messages is that informality is closely linked to education and skills. Informal workers generally have lower levels of education, while many firms report difficulty finding qualified employees.

This creates a skills mismatch that limits both job creation and economic growth. The report argues that investments in education, vocational training, and workforce development could have a bigger impact on reducing informality than many traditional formalization programs.

For policymakers, the lesson is clear: improving human capital is not only an education objective but also a labor market and growth strategy. Better-skilled workers are more likely to access productive jobs, while firms gain access to the talent they need to expand.

Rethinking Social Protection

The report also raises important questions about how social protection systems are designed. In many countries, access to pensions, health insurance, and other benefits depends on having a formal job.

However, labor markets are changing. Workers increasingly move between salaried employment, self-employment, gig work, and informal activities. As a result, tying social benefits exclusively to formal employment leaves many people unprotected.

The authors argue that governments should move toward more universal and portable systems that follow workers regardless of where they are employed. Such reforms could expand coverage while reducing incentives for workers and firms to remain outside the formal economy.

A New Roadmap for Policymakers

The report ultimately argues that informality should not be treated simply as a legal or administrative problem. Instead, it reflects deeper issues involving worker preferences, skills, business conditions, labor regulations, and social protection systems.

For governments, the policy message is significant. Rather than focusing narrowly on registering firms or enforcing compliance, policymakers should pursue a broader strategy that improves education, supports productive businesses, modernizes labor regulations, and expands universal social protection.

The report's most important contribution may be its reminder that workers are not passive participants in the labor market. They make choices based on what they value, whether that is income, flexibility, security, or independence. Understanding those choices can help governments design policies that not only reduce informality but also create better jobs, stronger businesses, and more inclusive economic growth.