This report examines and maps the characteristics and incentive structure of the institutional environment that has led to the prevalence of informal employment in three MENA countries, namely, Egypt, Morocco, and Tunisia. The report builds on the framework put forward by Levy and Cruces (2021), who argue that informality is endogenous to the legal, regulatory, and institutional contexts in which firms and workers operate and make economic decisions. The size of the informal sector is thus not a given; instead, it grows or shrinks, depending on a country’s economic environment. In other words, informality does not represent a constraint in itself; rather, it is an outcome of the institutional context that economic agents face.

The report analyzes the economic environment in three broad realms: entrepreneur-worker relations, taxes and transfers, and market conditions. For example, the design of social insurance systems affects employers’ and workers’ preferences to operate formally because of factors such as contribution rates, risk coverage, and the quality of the services provided. Similarly, if the tax burden associated with operating formally (fully or partially) is high and enforcement is weak, economic agents may opt to operate informally. Informality can also prevail for other reasons: if it is costly for firms to register their business or resolve commercial disputes, if it is cumbersome or risky to obtain credit because of high collateral requirements or uncertainties linked to the protection of borrowers’ and lenders’ rights, or if markets are incontestable due to corruption and unfair competition. Whatever the reason, if firms and workers perceive few benefits from operating formally, or if the benefits are low compared to informal alternatives, informality will remain high.