The informal sector is generally understood to refer to very small-scale units producing and distributing good and services, involving little or no capital, using a low level of technology and skills and therefore operating at a low level of productivity, and generally yielding very low and irregular incomes. These units are for the most part unrecorded in official statistics; they tend to have little or no access to organized markets, credit, training or public amenities. Neither recognized, supported nor regulated by the government, they are compelled by circumstances to operate outside the framework of the law and of social protection. Their workers generally live and work in appalling shanty-town conditions.
Informal sector activities take many forms. At one end of the spectrum is the relatively thriving small-scale manufacturing enterprise employing several workers; at the other end are street vendors, shoe-shiners and other engaged in petty service activities that yield barely a subsistence income. In between are such activities as informal transport services, small shops and laundries.
The sector's existence on the fringes of the law has often led public authorities to confuse it with criminal activities, and to subject it to harassment. Government strategies which have favoured urban development and large capital-intensive enterprises have produced biases which operate to the disadvantage of the informal sector, but ironically preserve it. The informal sector is also the very antithesis of everything that the trade union movement stands for – huge masses of people living and working in substandard conditions without the protection of the law or of organized labour. A comparable challenge is faced by employers' associations, whose membership until now has consisted largely of enterprises in the modern sector. The prospects for the integration of the informal sector into the mainstream of economic life will to a substantial degree depend on the engagement of both government, and worker and employer organizations.
The ILO gave the sector its name when an employment mission to Kenya in 1972 observed the phenomenon of large numbers of working poor in urban areas operating outside the formally structured economy.
Informal sector earnings are income for 300 million people. In some countries it contributes a third of gross domestic product. In India, it has been estimated that the underground economy is financially as important as the official economy.
The informal sector can be viewed from many angles. It can be seen as a provider of employment and incomes to million who would otherwise lack the means of survival, or viewed as a segment of society that escapes regulation and protection. It can be romanticized as a breeding ground of entrepreneurship or condemned as a vast sea of backwardness and poverty. However one looks at it and, contrary to popular beliefs, the informal sector is not going to disappear spontaneously with economic growth. It is likely to grow, and with it the problems of urban poverty and congestion will also grow.
The absence of unemployment benefits forces people to find some way of earning money, for example as a shoeshine boy. Labour in the informal sector is typically characterized by low levels of productivity and income, and must face a high degree of instability of employment. Remuneration tends to be too low to provide workers with an adequate standard of living for themselves and their families.
The persistence of the informal sector is due to the inability of the other sectors of the economy to provide jobs to a rapidly growing labour force. It can be described as a huge "labour sponge", a convenient, low-cost way of absorbing labour that cannot be employed elsewhere.