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Rethinking Indonesia’s Informal Sector

Author

Listed:
  • Rothenberg, Alexander D.
  • Gaduh, Arya
  • Burger, Nicholas E.
  • Chazali, Charina
  • Tjandraningsih, Indrasari
  • Radikun, Rini
  • Sutera, Cole
  • Weilant, Sarah

Abstract

This paper reviews competing theories about the causes of informality in developing countries and uses new data to determine which theory best explains the persistence and scale of Indonesia’s informal sector. Using nationally representative survey data on micro, small, and medium-sized firms, we find that most of Indonesia’s informal firms are very small, micro firms, with less than five employees. These firms pay low wages, are relatively unproductive when compared to large firms, are managed by individuals with low educational attainment, predominantly supply products to local markets, and have not recently attempted to expand their operations. From a small-scale, qualitative survey of firms, we find that many informal firms do not register their businesses either because they have no desire to expand or borrow from formal financial sources, or because they are avoiding taxes. Finally, we evaluate the impact of Indonesia’s one-stop-shops for business registration program, a large-scale program that attempted to reduce registration costs. We find both that the program had no effects on firms’ informality rates, and we also find that it did not reduce the probability that workers were informally employed. Taken together, the evidence suggests that a combination of the rational exit and the dual economy theories best explains why so many firms in Indonesia are informal.

Suggested Citation

  • Rothenberg, Alexander D. & Gaduh, Arya & Burger, Nicholas E. & Chazali, Charina & Tjandraningsih, Indrasari & Radikun, Rini & Sutera, Cole & Weilant, Sarah, 2016. "Rethinking Indonesia’s Informal Sector," World Development, Elsevier, vol. 80(C), pages 96-113.
  • Handle: RePEc:eee:wdevel:v:80:y:2016:i:c:p:96-113
    DOI: 10.1016/j.worlddev.2015.11.005
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    References listed on IDEAS

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    Cited by:

    1. Alexander D. Rothenberg & Samuel Bazzi & Shanthi Nataraj & Amalavoyal V. Chari, 2017. "When Regional Policies Fail An Evaluation of Indonesia's Integrated Economic Development Zones," Working Papers WR-1183, RAND Corporation.
    2. Floridi, A. & Demena, B.A. & Wagner, N., 2019. "Shedding light on the shadows of informality : A meta-analysis of formalization interventions targeted at informal firms," ISS Working Papers - General Series 642, International Institute of Social Studies of Erasmus University Rotterdam (ISS), The Hague.
    3. Alexander D. Rothenberg & Samuel Bazzi & Shanthi Nataraj & Amalavoyal V. Chari, 2017. "Assessing the Spatial Concentration of Indonesia's Manufacturing Sector Evidence from Three Decades," Working Papers WR-1180, RAND Corporation.
    4. Jessen, Jonas & Kluve, Jochen, 2019. "The effectiveness of interventions to reduce informality in low- and middle income countries," Ruhr Economic Papers 814, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    5. repec:rom:mrpase:v:9:y:2017:i:2:p:27-46 is not listed on IDEAS
    6. Shrestha, Rashesh & Coxhead, Ian, 2018. "Export boom, employment bust? The paradox of Indonesia's displaced workers, 2000-14," CEI Working Paper Series 2018-6, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
    7. repec:eee:wdevel:v:109:y:2018:i:c:p:511-522 is not listed on IDEAS
    8. Diao, Xinshen & McMillan, Margaret, 2018. "Toward an Understanding of Economic Growth in Africa: A Reinterpretation of the Lewis Model," World Development, Elsevier, vol. 109(C), pages 511-522.
    9. Christine Lewis, 2019. "Raising more public revenue in Indonesia in a growth - and equity-friendly way," OECD Economics Department Working Papers 1534, OECD Publishing.

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    Keywords

    informal economy; informal sector;

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