Business Visibility and the Measurement of Informality: A Multidimensional Latent Variable Index
This paper validates a multidimensional latent variable index for measuring business informality in Colombia by introducing a "Non-concealment" dimension of visibility and traceability, which yields significantly higher informality estimates than conventional compliance-based measures.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
The economy is not a single, solid block of activity; it is a landscape with both visible peaks and hidden valleys. For decades, economists and policymakers have tried to map the "informal economy," the vast sector of businesses that operate outside the official rules of registration, taxation, and labor protection. These are the street vendors, the unregistered workshops, and the small shops that do not file tax returns or pay social security for their workers. Understanding this hidden world is crucial because it holds the key to how much wealth a country is actually producing and how many people are truly protected by the law. However, measuring it has always been a difficult task. The standard way to find these businesses is to ask them directly in surveys, but this approach has a fatal flaw: people are often afraid to admit they are breaking the rules. They may lie to avoid trouble, or they may simply forget to mention their unregistered work because they do not want to draw attention to themselves. This fear creates a blind spot, making the informal economy look smaller than it really is.
To solve this puzzle, a team of researchers from the Parthenope University of Naples turned their attention to Colombia, a country with a sophisticated system for tracking its small businesses. They used data from a massive national survey called EMICRON, which collects information from hundreds of thousands of micro-enterprises between 2019 and 2024. The researchers wanted to test the official method used by Colombia's statistics agency, DANE, which measures informality based on a checklist of compliance: Did the business register? Do they pay taxes? Do they have health insurance for their workers? The team suspected that this checklist, while logical, might be missing the full picture because it relies entirely on asking people if they are following the rules. They proposed a new way of looking at the data, one that included not just what businesses say they do, but also how visible and traceable they are in the real world.
The researchers built a new measurement tool that treats informality not as a simple "yes or no" switch, but as a complex, hidden trait that reveals itself through many different clues. They started by testing the existing official model, which groups businesses into categories like "entry" (registration), "inputs" (labor rights), and "taxes." When they analyzed the data, they found that the old model had structural weaknesses. Some of the questions were asking the same thing in slightly different ways, creating confusion in the math, while other questions were so sensitive that many people refused to answer them, leaving gaps in the data. To fix this, the team refined the model, removing the redundant questions and focusing on the clearest signals of formality. They then added a new category they called "non-concealment." This dimension did not ask, "Did you pay your taxes?" Instead, it asked observable questions: Does the business have a website? Does it use a trade name? Does it accept credit cards, or does it only take cash? Is it located in a visible storefront, or is it hidden in a private residence?
The logic behind this new approach is that businesses trying to hide their activities will naturally avoid leaving a digital or public trail. A formal business usually wants to be seen to build a reputation, while an informal one often tries to stay under the radar to avoid scrutiny. By including these "visibility" clues, the researchers could catch businesses that might have lied about their tax payments but could not hide the fact that they had no website, no trade name, and only accepted cash. When they compared their new, refined model against the official government numbers and other simpler methods, the results were striking. The new model consistently identified a much larger informal economy. On average, it estimated that nearly 80 percent of employer micro-enterprises were informal, a figure that was about 11 percentage points higher than the official government estimate and roughly 80 percent higher than a simple measure that only looked at whether a business had a tax ID number.
The study suggests that the traditional way of measuring informality, which relies heavily on asking people to confess their compliance, significantly underestimates the true size of the hidden economy. The official numbers, while useful, are likely too low because they are skewed by the fear of disclosure. The new model, by weaving together labor compliance, tax records, and the simple fact of how visible a business is, provides a more complete and honest map of the economic landscape. It shows that the informal economy is not just a matter of who has a piece of paper from the government, but a complex web of behaviors where businesses actively try to remain invisible. The researchers found that these different aspects of informality—labor, taxes, and visibility—are deeply connected, moving together as a single, underlying phenomenon.
This work does not claim to have solved the mystery of the informal economy forever, but it offers a powerful new tool for seeing it more clearly. The researchers demonstrated that by looking at the things businesses do to hide, rather than just what they say about following the rules, we can get a much truer count of who is working outside the system. The findings suggest that in countries where people are afraid to admit to tax evasion or labor violations, looking for the lack of a website or the absence of a business name can serve as a reliable backup. It is a reminder that the economy is often defined by what is not seen, and that to understand the whole picture, we must learn to read the silence and the shadows as carefully as the official records.
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