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Covid 19 and the Informal Economy

Measures to combat the spread of Covid-19 have had far-reaching consequences, particularly in developing countries such as Zimbabwe. Social distancing has meant that most households and individuals are economically inactive and cannot generate any income. While an estimated 88.7% of working-age people in Zimbabwe are economically active, the vast majority earn a living in the ballooning informal sector, where incomes are hard to track or tax. The explosion of an informal sector in Zimbabwe has also spawned a long chain of middlemen, traders and cross-border operators suggesting a highly active underground economy.

 The IMF recently completed a study that measures the Shadow Economy of 158 countries (as a percentage of the formal economy). The results show that the three largest shadow economies are Zimbabwe with 60.6%, Bolivia with 62.3% and Georgia with 64.9%. The three smallest shadow economies are Austria with 8.9%, the United States with 8.3% and Switzerland with 7.2%.  Social distancing has meant that informal activity hotspots such as Mbare Msika in Harare and the Sakubva Market in Mutare have been shut down as the government continues with its lock-down measures.  However, a recent study by Yale University cites that gains from social distancing are smaller in poorer countries. The researchers note that the opportunity cost of social distancing is larger in poorer countries. Generally, rich people can more easily meet their basic needs during social distancing. However, a poor person may need to prioritize income-generating opportunities to put food on the table. A key question is; “What will the structure of the Zimbabwe economy look like post the lock-down period?

It is worth noting that limited social safety nets in Zimbabwe mean that household incomes have been eroded, particularly those that depend on the informal sector. However, the need to “survive” will encourage more economic players to informalize. We therefore expect a much larger informal economy post the lockdown period. A number of factors that encourage the development of large informal sector are still in place and these include;

  • The poor quality of public institutions. A bureaucracy with highly corrupt government officials tends to be associated with larger unofficial activity, while good rule of law through securing property rights and contract enforceability increases the benefits of being formal. In fact, production in the formal sector benefits from higher provision of productive public services and is negatively affected by taxation, while the shadow economy reacts in the opposite way. In this case, an informal sector develops as a consequence of the failure of political institutions to promote an efficient market economy as entrepreneurs go underground due to inefficient public goods provision;
  • High levels of unemployment. The higher the rate of unemployment, the higher the probability to work in the shadow economy, ceteris paribus; and
  • Economic contraction. The development of the official economy is a key factor in the shadow economy. The higher (lower) the unemployment quota (GDP growth), the higher the incentive to work in the shadow economy, ceteris paribus. The image below captures the impact of Covid-19 on global economic growth;

Overall, a larger shadow economy is associated with more economic activities moving out of the formal economy and this also shows a decrease in economic growth. Piggy maintains a view that mass-market food items will prove to be more defensive than luxury goods in the outlook period. Investors can play this theme by investing in Innscor Africa, Dairibord Holdings, National Foods, and OK Zimbabwe.

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