The effect of the informal sector on sustainable development: Evidence from developing countries

Abstract

AbstractThis study aims to explore the impact of the informal sector on the sustainability of development. A large panel data set of 50 developing countries that spans over 2010–2019 has been utilized to this end while the informal sector is evaluated in terms of working poverty. Selecting indicators from three dimensions of sustainability, that is, economy, society, and environment, this study has constructed three indices and combines those to construct a symptomatic composite index of sustainability. Both the short run and long run panel data models have been applied to empirically investigate the impact of informal economic activities on the sustainability of development. Economic growth, national expenditure, and economic freedom of countries are used as control variables in the models and the estimated outcomes are found to be robust in empirical investigations. The outcomes of the study imply that the informal sector plays a detrimental role in the sustainable development of developing countries while economic growth and economic freedom contribute positively. Therefore, the prescribed strategy is to reduce informality from business and other economic activities that limit the scope of the economies and to understand the domain through which interventions can be made to move to a more formal economy. Integration of informal business and SMEs into the formal sector and firm‐level awareness building in Corporate Social Responsibility can also be suggested to find a path towards sustainable development in addition to increased economic growth and enhanced economic opportunities of the developing countries.