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The Informal Sector under

Capitalism and State Socialism:
A Preliminary Comparison
Alejandro Portes and J?zsef B?r?cz

of themost important recent discoveries in the field of economic

sociology concerns the close-to-universal extent and the explanatory
significance of the informal sector. This article will discuss some of
itsmost fundamental characteristics under capitalism and state socialism.
The informal sector is defined as all productive and distributive income
earning activities which take place outside the scope of public regulation on
themacrosocietal level.
Although the concept of the informal sector was originally coined with
reference to urban economies in theThird World, its scope extends far beyond
the poorest countries: the informal sector produces a respectable share of the
gross domestic product (GDP) in such advanced countries as the United
States, Italy, theNetherlands, theUnited Kingdom, or Spain. Furthermore, and
perhaps more surprisingly for outside observers, informality is so widely pre?

sent under existing forms of state socialism that any inquiry into the actual
social, political, and even cultural processes of the supposedly
"centrally planned economies" is bound to be misspecified unless it takes into
consideration the socialist informal sector.
In most socialist states, due to orthodox ideological hostility against the
"petty bourgeoisie," "refrigerator-socialism," and all forms of individualism in
general, official statistics reveal little about the exact size of informality.
Grossman (1989) estimates that about one-third of Soviet households received
at least 25% of their income from informal sources during the late 1970s. Sur

is John Dewey Professor of Sociology and International Relations
Johns Hopkins University, Baltimore, MD 21218.
is a doctoral student in Sociology at Johns Hopkins University, Baltimore,

MD 21218.

Support for data on which this article is partially based

tion,Tinker Foundation, and Sloan Foundation.

Social Justice Vol.

came from grants from the Ford Founda?

15,Nos. 3-4 17

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Portes and B?r?cz


where most systematic research has been
vey data suggest that inHungary
carried out on informality under state socialism ?
roughly three-fourthsof
both families and individuals had been drawing incomes from the informal
sector during the early 1980s, prior to the large-scale legalization of various
informal arrangements (Kolosi, 1984). In the same period, informal activities
were estimated to represent almost 40% of all net population incomes?
proximately 20% of the total gross national product (GNP) (Galasi and
Szir?czki, 1985: 131). By 1986, the informal sector absorbed about 33% of the
total basic labor time of the population according to a time-budget micro
census taken by theHungarian Central Office for Statistics (KSH, 1987: 13).
Informality as Opposed


Logically, the firstdistinction to be made when comparing the informal

sectors under the two sociopolitical regimes concerns the central macro
societal condition which creates "space" for informality to emerge.
Under capitalism, certain productive and exchange processes shift into, or
emerge as inherentlynested within, informalityas a result of a mix of market
forces and state action. As noted elsewhere (Castells and Portes, 1989), infor?
mality under capitalism arises as a reaction to:

Union power;


The regulation of the economy by the state through taxation and so?
cial legislation;


International competition;


The inability of Third World industrialization to fulfill previously

established labor regulations; and

Economic crises.
Based on the experience of the last two decades regarding the spread of in?
formal arrangements under capitalism, we have argued elsewhere that infor?
matization ismost likely when a profit squeeze, brought about by increasing
labor costs or competition from cheaper foreign goods, combines with the pos?
sibility of decentralizing work arrangements and the availability of a labor
force to do so (Portes and Sassen-Koob, 1987: 54).
On the other side, the central distinguishing characteristic of state social?
ism is the dominance of the polity over other domains of social reproduction.
In these regimes, planning represents, as itwere, the gigantic embodiment of
social teleology: it is the state's main instrument to insure that itspolitical will
should prevail over economic considerations (B?r?cz, 1987). The bureaucrati

zation of planning and the resulting pervasive shortages of capital, labor, and
commodities are the two most common deficiencies of state socialist
economies (Kornai, 1980).

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Informality under Capitalism and State Socialism


The second economy emerges under such conditions as a partial corrective

to the rigidities of the system, thus easing participation in the economy and
survival for individuals, households, companies, and, perhaps paradoxically,
even the state itself.1Hence, the appearance of the second economy is the out?
come of a combination of market and state factors, not unlike the situation
under capitalism. The main difference lies in the relative strength of market
and state with respect to each other?
namely, the state's overwhelmingly
dominant position under state socialism.
Informality under capitalism includes all processes throughwhich other?
wise licit products or services are produced and/or distributed outside the
state-regulated segment of themarket of labor, capital, and commodities. In
contrast, socialist second economies involve theproduction and distribution of
licit products outside the channels of centralized planning and direct state

Since the functioning of the second economy poses a potential threat to the
the unidirectional link from the polity to the econ?
monopoly of planning
economy represents a terrainof political struggle "per se."
This political aspect of formal-informals relation was clearly revealed, for in?
stance, in theHungarian state's unprecedented tolerance of early demands for
new informal arrangements in agriculture. The result? micro-plot ("around
the-house") informal farming in a symbiotic relationship with large farms
was a compromise solution reconciling the inherent breach of interests be?
tween the state and the peasant segment of civil society. It is this inherently
politicized nature of the second economy thatprevents it from being legalized
inmany socialist states.
What Activities Are Informalized?
Informality extends to an extremely diverse set of productive and distribu?
tive enterprises. Under capitalism, peripheral and advanced alike, informal
economic activities have been detected in a broad gamut of sectors ranging
from themost technologically backward to themost advanced. Examples from
the literature include the footwear, garment, food, drink, construction, con?
struction materials, electronics, and chemicals industries in Guadalajara,
Mexico; footwear production and recycling inMontevideo, Uruguay; the con?
struction and garment industries, public transport and auto repair services in
Bogota, Colombia; plastics, toys, and electronics industries inMexico City;
construction, apparel, toys, sporting goods, furniture, fixture, footwear, pack?
aging and electronics industries, transportation and auto repair services, and
retail trade inNew York City; hotels and restaurants, textiles, and construction
activities inMiami; seasonal tourist services, industrial counseling, personal
household services, and artisanal activities in Emilia-Romagna,
Italy; and
footwear, garment, and toymanufacturing, the electronics industry and sea

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Portes and B?r?cz

sonal agricultural work in Spain. (See Roberts, 1989; Sassen-Koob,

Fortuna and Prates, 1989; Lanzetta and Murillo, 1989; Stepick, 1989; Blanes,
1989; Benerfa, 1989; Capecchi, 1989; Ybarra, 1989; Benton, 1989.)
In turn, the second economy extends to food production and trade, second?
hand goods, medical payments, and a host of services and perquisites in the
Soviet Union (Grossman, 1989). In Hungary, it is the dominant form of eco?
nomic organization in such diverse areas as computer software production and
trade, automobile and urban household repair services, foreign language in?
struction and translation services, low- and medium-priced tourist accommo?
dations and restaurants, ice cream parlors, urban taxi services, customized en?

tertainmentelectronics, and high-brow boutique enterprises. Hungary's trade

in such best-selling agricultural export items as wines, fruits,pork, goose liver,
and feathers depends almost entirely on production in the second economy.
Rural house-building is performed almost exclusively through reciprocal labor
exchange arrangements without any involvement by the state-run construction
industry (B?r?cz, 1987; Galasi and Szir?czki, 1985; Gabor, 1985; Sik, 1985
and 1986).
As far as concrete forms of economic organization are concerned, the in?
formal economy extends?
under capitalism as well as under state socialism
to subsistence agriculture, petty commodity production (especially in
farming), piece-rate work, entrepreneurship on widely varying scales, indus?
trial sweatshops, and various modern-day versions of the old putting-out sys?
tem through housework. Informal trade ranges from casual street vendors
throughcorner stores to complex smuggling operations.

Hungary has recently developed a unique type of institutional articulation

between the formal and informal sectors, called "business work partnerships."
These informal, internal entrepreneurial units are recruited among employees,
and operate within the confines of state-owned and bureaucratically managed
companies (Stark, 1986; 1988). They use company equipment and frequently
perform the same or very similar tasks as those assigned to theirmembers as
individual employees during regular hours. These partnerships combine fea?
tures of informal shop-floor organization ?
characterized by entrepreneurial
freedoms unparalleled within firms in the socialist state-owned sector?
top-to-bottom internal labormarket control by management.
This rich, multicolored mosaic does not emerge at random, but rather pos?
sesses a clear internal logic.What is common among these particular sectoral
and organizational forms is thepredominance of labor-intensive economic ac?
tivities.Under capitalism as well as state socialism, high capital intensitypro?
duction and trade tends to remain formal and regulated. Capital-intensive ac?
tivities do not lend themselves easily to informatization if, for no other reason,
thephysical characteristics of the equipment prevent it.The most general fea?
turesof the sectors of the economy penetrated by informal activities in the ad

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Informality under Capitalism and State Socialism

capitalist countries, under state socialism, and in the Third World

the need forflexibility to accommodate structuralrigidities, unfore?
seen fluctuations in business conditions, seasonal variations, and structural
changes resulting from business cycles.



and Nonmarket Components

of Informality

An essential feature of informal production and distribution is that it repre?

sents the articulation ofmarket processes with nonmarket features of the social
settings where it occurs. The most notable types of these nonmarket aspects
involve: (a) direct control by the state of labor inflows; (b) race, ethnicity,

gender, and age of workers; and (c) family- and kin-based social dynamics.
Observers of the informal sector in theUnited States first interpreted the
phenomenon as the outcome of the presence of a sizable immigrant popula?
tion, essentially arguing that informality in thewealthier countries was created
and maintained by recently arrived immigrant communities. Subsequent re?
search has shown thatwidespread informality can and, in fact, does exist
under advanced capitalism in the absence of or without the involvement of any
immigrantgroup.We add that the experience of state socialist societies further
supports this argument: the second economy is in no way causally connected
with any immigrant group in those countries where immigrants represent, in
any case, a minuscule proportion of the population.
To be sure, immigration and the informal sector are closely related in some
countries. The state's regulations regarding labor immigration represent a set
of bureaucratically enforced nonmarket controls, which are often used to re?
strictor expand the pool of vulnerable and disposable labor.Without immi?
gration restrictions, based on the territorial sovereignty of advanced modern

states, global wage levels would eventually reach parity, and the global dis?
placement of either capital or labor in search of economic advantage would
lose its raison d'etre. Tacit tolerance of clandestine immigration, coupled with
major efforts at keeping it outside the law, have been a characteristic strategy
of U.S.-government policy until recently.Under such conditions, immigrants
represent an ideal labor pool for the underpaid and unprotected jobs available
in the informal economy.

Ethnicity, race, gender, and age are an additional set of social characteris?
ticswhich play an importantorganizing role in the functioning of the informal
sector. In contrast to bureaucratically administered state regulations, they are
normatively enforced on a macrosocietal scale. All of them are ascriptive divi?
sions or groupings which exist in the society, with or without the presence of
informal practices. It has been observed, however, thatmembers of discrimi?
nated ethnic and racial groups tend to be overrepresented as workers in infor?
mal enterprises. Strong support for this observation is lent by evidence from
sweatshops and subcontracting arrangements inNew York City and other ar

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Portes and B?r?cz


eas of the advanced capitalist world, and by housemaids, piece-rate, and

putting-outworkers inThird World countries as well as by certain branches of
the second economy under state socialism (e.g., ethnic Gypsies specializing in
feather collection in Hungary). The existence of socially ascribed negative
stereotypes of a particular group facilitates theirwillingness to accept unpro?
tected and poorly paid work in general, thus propelling them towards infor?
mality. Industrial subcontractors in the United States as well as in Latin
America who make use of unprotected labor also have a clear tendency to pre?
fer a young and female workforce forobviously similar reasons.
Family- and kin-based organization is a thirdmajor type of nonmarket

control mechanism which is often utilized in informal enterprise. It is also

normatively enforced, but it occurs at themicro-level, most typically within
the confines of the household. The often-praised superior efficiency of micro
plot farming in socialist countries, for example, is suspected to be an artifact
of unpaid family work ? mostly women's and children's labor. The same is
the case with subsistence farming and agricultural petty commodity produc?
tion virtually everywhere in the Third World:
the economic principle of
arrangements transform
the unpaid work of socially and economically dependent familymembers into
material value.
The translation of nonmarket controls intomarketable commodities repre?
sents, in fact, the principal economic outcome of state-insured vulnerability of
immigrant workers, ascribed subordination and discrimination of certain
groups, and family bonds. The informal sector converts these bureaucratically
or socially enforced norms into economic processes whereby the remuneration
of labor represents a fraction of what itwould otherwise be under "normal"
conditions. Hence, the various social groups subordinated to these nonmarket
controls in effect subsidize the growth of informalbusiness activity.

Labor Costs and Social Class Effects

Under capitalism, the informalworking class also subsidizes business by

partially absorbing the costs of the reproduction of labor. Informality,by defi?
nition, does not provide the same occupational safety and medical care
"umbrella" for its participants as does its formal counterpart. Similarly, long
term labor reproduction costs? maternity support, education, and retirement
are also obviously absent from informal arrangements. Although many
workers in Third World countries alternate formalwith informal employment,
recent evidence indicates that themajority of those in the unprotected sector
have no other recourse. In Latin America, this has resulted in the development
of a large and stable informal proletariat (Portes, 1985).
By contrast, all socialist states have, very early after their establishment,
arranged for basic

social security, educational, health, and retirement provi

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Informality under Capitalism and State Socialism


sions for their populations. With the exception of retirement benefits, which
are tied to employment, all other welfare provisions are conferred through citi?
zenship. Thus, social welfare spending is, to a large degree, equalized. Fur?
thermore,participation in the second economy tends to be, for themost part, a
part-time pursuit. The typical pattern in countries like the Soviet Union, Hun?
gary, and Poland is to keep one's employment in the "first" economy
state- and cooperative-run sector
and to add various part-time activities in
the second economy (Galasi and Szir?czki, 1986). As a result, a relatively
large proportion of the population occupies dual, and even triple class posi?
tions based on their sectoral involvement (B?r?cz, 1987).
Under this system, statewelfare provisions cover the entire population, in?
cluding work performed in the firstas well as in the second economy. If there

is any flow of subsidies in this arrangement, itoccurs from the state to the sec?
ond economy. Obviously, since the state does not generate any resources of its
own, under state socialism the economy as a whole tends to subsidize part of
the reproduction costs of labor performed in the second economy through
state-mediated redistributive channels. Thus, the two principal subsidies al?
lowing the second economy to function come from unpaid family work, ac?

quired through normatively enforced controls at the household level, and from
the society at large throughprocesses of state redistribution.
Under capitalism, there is a consistent income differential favoring formal
over informalworkers. Within the informal sector itself, there is also a sharp
dividing line between entrepreneurs and theirworkers in termsof their relative
income levels. Evidence fromLatin America indicates thataverage incomes of
informal entrepreneurs triple or quadruple those of workers in this sector and
exceed significantly even those of the formal proletariat (Portes and Benton,

Under state socialism, the second economy is a source of a different
structuraldifferentiation of income levels.Most working members of the soci?
ety receive incomes in kind through the state's welfare provisions and from
jobs in the "first" economy. In terms of money incomes, themajor distinction
drawn is between those who are involved only in the state- and cooperative
run sector and those who have access to additional incomes from the second
economy. Due to the low average income levels in the socialist sector and to
the fact that the informal enterprise supplies goods and services in high de?
mand, income levels of all workers in the second economy tend to be higher
than those in comparable positions in the first.Except formembers of the po?
litical elite, the bureaucratic apparatus, and topmanagers, noninvolvement in
the second economy is, under these conditions, a sign of grave economic
As they are forced to subsidize part of reproduction costs of their labor
power under capitalism, informal sector workers rely on various nonmarket

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Portes and B?r?cz


and informalmarket channels tomake up for the deficit, thus creating a sec?
ond circle of enterprise in informal welfare provisions (Sassen-Koob,
Under state socialism, in contrast, the second economy tends to penetrate
state-managed redistributive systems of social welfare, health care, education,
etc. This latterphenomenon has been labelled corruption, reciprocal exchange
of influence, bribery, tipping, etc. All of its variants involve a formally egali?

tarian system of basic benefits, whose available supply is shorter than demand
or whose quality is less than satisfactory. As these benefits are disposed in
kind throughbureaucratic channels, inequalities are reintroduced into the sys?
tem through informally arranged privileges.
Thus, the ultimate effect of large-scale informalization on social services

turnsout to be rather similar under capitalism and state socialism: under both
systems, there is increased reliance on such channels in order to satisfy basic
needs for the reproduction of labor. Under one set of circumstances, informal
channels emerge spontaneously in order tomake up for the absence of state
provided services; under the other, they essentially colonize the existing, for?
mally universalistic state service system.

Effects of Informality

Informality under capitalism tends to put downward pressure on earnings

in twoways:

Through circumventing labor protection legislation, it decreases av?

erage labor costs of the society in general; and

Through direct competition, it decreases either the size of the higher

paid formal labor force or its level of remuneration (Portes and
Sassen-Koob, 1987).
Under state socialism, the effects of informality on average earnings are
just the opposite:


By circumventing the rigidities of planning and direct bureaucratic

major obstacles in theway of increasing wage levels in the
formal sector?
itprovides additional sources of income.

By syphoning off part of thework capacity of the best qualified and

most reliable workers, it pressures the formal sector to invent direct
or indirectways to accommodate wage demands in order to retain at
least part of its labor force.
This may or may not involve direct remuneration: one alternative reported
in the literature is tolerance of labor's absenteeism, while another is the provi?
sion of better tools, organization, and raw materials in those sectors where re?
muneration is tied to productivity through piece-rates (Stark, 1986). The re?

sulting shop-floor bargaining arrangements represent a move away from the

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Informality under Capitalism and State Socialism


an important change in the structureof so?
initial plan-command structure
cial control at theworkplace (B?r?cz, 1987).
Informality increases profitability under capitalism by reducing labor costs
and increasing the flexibility of production arrangements. In thismanner, the
informal sector contributes to the long-term survival of a particular regime of
accumulation. Ironically, the second economy has a similar preservative effect

under state socialism: by partially correcting the deficiencies of the system, it

contributes to the survival of itsmajor actors, thus fostering themaintenance
of thisparticular regime of power.
However, this relatively benign, functional role of informality is not limit?
less under either system. If the informal sector incorporates a sufficiently large
share of the population, it can in effect paralyze the statemachinery by ex?
hausting its revenues. The blockage of state revenues further depletes the
quality and extent of social welfare provisions and the capacity of the state to
regulate the economy, thus drivingmore firms and workers out in a seemingly

endless spiral of informalization. This process may encourage the emergence

and solidification of unchecked authoritarian regimes, as seen in some Third
World societies.
The process also threatens to overstrain the capacities of the labor force.
Informal sector workers under capitalism are often forced towork long hours,
either under compulsion from theiremployers, or under self-compulsion stim?
ulated by a piece-rate system. In addition, immigrants, women, and other
groups caught in these situations are forced to combine wage-earning labor
with a host of other subsistence activities, adding to extremely long work days
(Ybarra, 1989; Fortuna and Prates, 1989). In socialist countries, a noted effect
of informal jobs combined with first sector employment has been a marked in?
crease in theper capita labor time of active wage earners, reaching at times
levels similar to those in late 19th-centuryEngland (KSH, 1987). The deterio?
ration of health, alcohol and drug abuse, and rising mortality among segments
of theEast European wage-earning population has been widely attributed to
Recent years have seen the discovery of the informal economy as an im?
portant area of research in economic sociology. To our knowledge, no attempt
has been made so far tomerge the insights of studies on such activities under
the two systems of politico-economic organization predominant in theworld
today. This article t^kes a first stab at this challenging, but complex, question

by highlighting similarities and differences in the form and effects of unregu?

lated activities under the two systems.
The expansion of the informal economy represents a double-edged sword
both to the regimes under which itgrows and to the individuals involved in it.

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Portes and B?r?cz


Under capitalism, informalization of certain sectors decreases thepower of or?

ganized labor and increases flexibility and profits for firms.Under socialism,
itprovides an "escape valve" and a means to circumvent supply bottlenecks in
rigidly planned command economies. Such contributions to the status quo re?

quire, however, that the process of informalization becomes a direct threat to

the state's regulatory powers ?
the very powers which make the existence of
a formal economy possible. Similarly, forworkers under both systems, infor?
mal employment offers an opportunity for survival and economic ascent.
However, availing oneself of such opportunities entails serious costs in terms
of difficult work conditions, long hours, and uncertainty. Under certain cir?
cumstances, informality represents a means of personal resistance to the ex?
isting political order. Under others, however, it undermines the collective
ability of organized workers to secure dignified labor conditions, minimal
protections, and reasonable wages. In such instances, informal individual
"solutions" end up jeopardizing long-term prospects for themajority of wage

Under capitalism, informality decreases union power, thusmaking labor

more vulnerable to themarket logic of capital and its allies in the state appa?
ratus. It is difficult to speak about union power in theWestern sense under
state socialism. Yet, the second economy makes a considerable impact on po?
liticalmechanisms under state socialism: it creates an avenue for civil society
tomanifest itself as distinct from the state, thusoffering a short-termand indi?
vidualistic, but nevertheless real, alternative to a politically controlled plan


1. Following Gabor (1979) and many subsequent analysts, we will use the term "second
economy" to denote manifestations of the informal sector under state socialism. For its counterpart
under capitalism, we use "informality under capitalism," etc.

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