Evolution of theories explaining the informal economy

This chapter reviews the evolution of theories explaining the informal economy. Four competing theories are reviewed, namely: modernisation theory which posits unmodern governance systems and economic under-development are the key drivers of the informal economy; neo-liberal theory which contends that too much government interference (e.g., high tax rates, burdensome regulations) is the determinant; political economy theory which contrariwise asserts that inadequate state intervention in work and welfare is the cause, and institutional theory which states that formal institutional failures produce an asymmetry between the formal rules, and norms, values and beliefs, and thus the greater prevalence of the informal economy. Charting the evolution of these explanations, this chapter shows that scholarship has shifted over time from the domination of modernisation theory through a period when the neo-liberal and political economy perspectives competed for dominance, to the present day when institutional theory has synthesised and incorporated the previous theorisations.