The economy you can't measure
Walk through any Latin American city and the real economy greets you before the official one does: the fruit seller on the corner, the mechanic working out of a lean-to, the seamstress paid in cash, the delivery rider whose platform contract dissolves into nothing when it rains. These are not marginal figures. In much of the region, they are the labour market.
Informality — work and enterprise that falls outside tax registration, labour law and social-security coverage — runs at roughly half the workforce across Latin America as a whole, and considerably higher in Central America and parts of the Andes. That means GDP, which captures the formal economy with reasonable accuracy, systematically understates output, obscures welfare and misleads policymakers about what is actually happening on the ground.
The causes are structural and mutually reinforcing. Labour regulations in many countries are designed for large formal employers and are effectively unenforceable for small ones. Payroll taxes and registration costs are high enough that compliance can price a microenterprise out of viability. Social protection is tied to formal employment, so the incentive to formalise is dulled when you cannot afford the entry ticket anyway. The result is a trap: the state under-taxes and under-services a huge share of the population, which in turn funds neither the public investment nor the credible institutions that might make formality worth the cost.
For investors and analysts, informality is not just a welfare story — it is a governance one. Monetary policy operates through the formal financial system; a large cash economy weakens its transmission. Fiscal policy loses reach when businesses and workers sit outside the tax net. Productivity suffers: informal firms stay small deliberately, because growth attracts scrutiny. The middle-income trap that has stalled so many Latin American economies is, in part, an informality trap — you cannot climb the value chain from the shadows.
Some countries have made genuine inroads. Brazil's Simples Nacional regime lowered the cost of formalisation for small businesses. Several governments have extended conditional cash transfers in ways that reach informal households directly. But the evidence on converting informal workers into formal ones at scale remains modest. The informal economy is not a remnant of underdevelopment waiting to be swept away; it is a rational response to the incentives the formal system actually offers.