Executive Summary

The conventional policy narrative on MENA's informal economy has often been built on a limited premise: that informality is primarily a challenge to be addressed through enforcement, regulation, and gradual absorption into formal systems (Deléchat & Medina, 2020). 

This policy brief challenges that premise. Across MENA, the informal economy employs between 45% and 80% of the workforce, depending on the country, and contributes an estimated 22% to 37% of GDP in North African states. It functions as a resilient, self-organized economic system that has endured decades of fiscal shocks, political crises, and structural adjustment programs, often filling gaps left by formal

institutions. To treat it only as a failure risks overlooking one of the region's most enduring economic assets.

We argue that MENA policymakers should reframe informality: not simply as a  problem to formalize away, but as an institutional reality to govern intelligently, one that, if engaged correctly, could expand the tax base, improve social protection coverage, drive SME growth, and accelerate financial inclusion without the social disruption that coercive formalization programs consistently produce.

Introduction: Rethinking Three Decades of Internal Economy Policy

For three decades, the dominant policy response to MENA's informal economy has followed a linear logic: informality is a symptom of underdevelopment; development means formalization; formalization requires regulatory enforcement. This logic has influenced structural adjustment conditions imposed by the IMF, World Bank reform programs, and national development plans across Egypt, Morocco, Tunisia, and Jordan (Deléchat & Medina, 2020). 

The outcomes highlight the limitations of this approach. Despite persistent reform efforts, informal employment rates in MENA have barely moved. Morocco's informal employment share, estimated at 80% by the ILO, is as high today as it was in the early 2000s. Egypt's informal economy, estimated at between 29% and 50% of GDP depending on the source, has not shrunk in response to successive formalization drives. Tunisia's informal sector, at 34% of GDP, has expanded rather than contracted during periods of economic liberalization.

The persistence of informality does not simply indicate policy failure; rather, it suggests that conventional approaches may have addressed only part of the problem. The informal economy in MENA is not only a transitional stage on the path to formal market development. It is a structural feature of economies where formal institutions have struggled to provide affordable access to credit, legal recognition, social protection, and viable regulation (Saoudi, 2022). 

This brief makes the case for a fundamental reorientation: from a policy of elimination to a policy of engagement.

The Scale of the Informal Economy: Measuring a Structural Reality

Employment

The International Labour Organization defines informal employment as the proportion of workers without access to social security. On this measure, informality in MENA is not a marginal phenomenon. It is the dominant form of economic participation across the region (ILO, 2023). 

  Source: ILO (2022/2023). Informal employment as % of total employment.

As Figure 1 illustrates, informal employment in MENA ranges from 45% in Jordan to 80% in Morocco, with Egypt at 63%, Tunisia at 59%, Iraq at 67%, and Syria at 70% (Saoudi, 2022; Aikins, 2023). 

In absolute terms, the informal workforce in MENA numbers is in the tens of millions. Eight in ten young workers aged 15-24 in the Arab States are informally employed. Among women, participation is often concentrated in more vulnerable forms of informal employment (ILO, 2024). 

GDP Contribution

The IMF estimates the informal economy averages 35% of GDP in low- and middle-income countries globally, compared to15% in advanced economies. MENA's North African economies cluster at the upper end of this range (IMF, 2021).

 Source: IMF (2023); World Bank (2023). Informal economy as % of GDP.

Figure 2 highlights a striking structural contrast: Lebanon and Morocco's informal economies approach or exceed 36% of GDP, while Gulf States, with heavily regulated formal labor markets anchored by large state employers and multinational firms, show considerably lower informal shares. This divergence reflects not just differences in economic development but in state capacity, labor regulation design, and the historical relationship between citizens and public institutions.

In Egypt alone, the informal economy was estimated at $67.2 billion in 2023, equivalent to the country's entire formal private sector investment pipeline. Even on conservative estimates, this represents a potential fiscal resource and growth engine that current policy frameworks have struggled to fully capture (Aikins, 2023). 

Sectoral Distribution

Informality is not uniformly distributed. It is concentrated most intensely in agriculture, where informal employment reaches 94-96% in Egypt and Morocco, but remains pervasive across industry and services, as Figure 3 below demonstrates (Lopez-Acevedo et al., 2023). 

 Source: World Bank (2023). Informal employment by sector - Egypt, Morocco, Tunisia.

The high prevalence of informality in industry and services, sectors with strong growth potential, is particularly significant. It means that the productive engine of MENA's future economic diversification is operating almost entirely outside the regulatory, fiscal, and social protection framework. Digital manufacturing, agri-processing, artisanal export industries, and retail services are all predominantly informal across North Africa.

Why Informality Persists: A Structural, Not Only Behavioral, Explanation

The cost of legality

Explanations of informality that focus primarily on tax avoidance or individual choices often do not fully capture the broader incentive structure. For many MENA informal enterprises, formalization is often unattractive because the perceived benefits do not always outweigh the compliance costs involved (Deléchat & Medina, 2020).

Labor market regulations in Egypt, Lebanon, Morocco, and Syria are among the most restrictive in the world relative to income level. A small Moroccan workshop owner formalizing their workforce must comply with a minimum wage regime, mandatory social security contributions, rigid dismissal rules, and sectoral collective agreements, a combined cost that can exceed 40% of the wage bill (Ahmed, 2011).

For a micro-enterprise operating on thin margins in a low-growth environment, these costs can represent a significant barrier to growth and formalization. Informality is therefore not always simply a choice to evade obligations; it can also represent a rational response to a formal system whose compliance costs are mismatched with the economic realities of small enterprise.

The access deficit: credit, markets, and institutions

Access to formal credit is among the most documented constraints on informal enterprise growth across MENA. World Bank data from Morocco shows that only 28% of formal SMEs had access to formal credit in 2019-20. For informal firms, the figure collapses to approximately 8% (Lopez-Acevedo et al., 2023). 

Source: World Bank (2023). Access to formal credit by firm size and formality status, Morocco.

Figure 4 illustrates the structural credit exclusion facing informal enterprises across North Africa and the Middle East. The gap between large formal firms and informal enterprises is not primarily a risk gap; it is a documentation gap. Informal enterprises cannot provide the collateral, tax records, or audited financial statements that formal banking systems require, even when some of their underlying economic activities could qualify for credit on assessments of viability.

This access deficit has compounding effects. Without credit, informal firms cannot invest in productivity-enhancing equipment, expand their workforce, or build the scale that would make formalization cost-effective. Informality and low productivity thus reinforce each other, not necessarily because informal firms are inherently less productive, but because the institutional barriers can limit their ability to grow (Lopez-Acevedo et al., 2023).

The Social Protection Trap

MENA's social protection systems are structured around formal employment as the primary vector of benefit delivery. Health insurance, pensions, unemployment benefits, and family allowances are in most MENA countries tied to formal employment contracts and social security contribution records (Saoudi, 2022). 

This creates a perverse incentive architecture. Workers who move from informal to formal employment may gain social security contributions but can also lose access to informal social networks, flexible working arrangements, and additional income sources that may represent important forms of security. In many cases, the formal system struggles to compete with informal arrangements because it was not designed around the realities of informal workers.

In Egypt, out-of-pocket health expenditure has remained persistently high despite formal health insurance systems, precisely because informal workers, the majority of the population, have no meaningful access to contributory health schemes (Lopez-Acevedo et al., 2023). 

The Untapped Potential of the Informal Economy

Macroeconomic Stabilizer

The informal economy can perform a macroeconomic stabilizing function that is often overlooked in traditional economic analysis. During MENA's recurrent fiscal crises - including Egypt's currency crises of 2016 and 2022, Tunisia's  sovereign debt challenges, and Lebanon's economic collapse - the informal economy absorbed many workers displaced from formal employment and helped reduce the social impact of economic shocks.

This buffer function is not incidental to the informal economy's character; it is structural. Informal enterprises can adjust wages, hours, and headcount far more rapidly than formal ones, partly because they operate with greater flexibility than formal enterprises subject to regulatory requirements (Saoudi, 2022). 

Entrepreneurial Ecosystem

MENA's informal economy is not exclusively populated by subsistence workers with no alternative. It contains a significant stratum of entrepreneurs: informal manufacturers, traders, digital service providers, and artisans who have built viable businesses despite operating without legal recognition, credit access, or institutional support.

Research suggests that many informal entrepreneurs in MENA share similar motivations, skills, and ambitions with formal entrepreneurs. What differentiates them is access: to capital, markets, information, and institutional recognition that allows businesses to grow (Saoudi & Lahzaoui, 2026). 

The implication is significant: the informal economy is not a pool of economically marginal activity. It includes economically viable activities that often operate below their potential because institutional barriers limit their ability to grow.

Social Fabric and Community Resilience

Informal economic networks in MENA cities; the souks of Marrakech, the workshops of Cairo's industrial periphery, and the street economy of Tunis are not just economic phenomena. They are social institutions that organize trust, credit, apprenticeship, and mutual support across communities where formal institutions often have limited reach.

Coercive formalization programs that disrupt these networks without providing adequate alternatives do not simply address tax gaps, they risk weakening forms of social capital that cannot be easily rebuilt. This is a dimension of informal economic policy that is almost entirely absent from the conventional literature.

Toward a New Policy Framework for the Informal Economy

The following recommendations depart deliberately from the standard policy toolkit, which has focused on simplifying business registration, reducing red tape, and strengthening labor inspectorates. Those measures have their place, but have had limited success in reducing informality at scale. What follows proposes structural interventions that engage the informal economy on its own terms.

Recommendation 1: Graduated Informality Recognition - Beyond Binary Legality

The central limitation of conventional formalization policy is its binary structure: enterprises are often classified as either formal (registered, taxpaying, socially insured) or informal (none of the above). This binary approach leaves limited institutional space for the vast middle ground where most MENA informal enterprises actually operate.

Proposed mechanism: The three-tier recognition framework

• Tier 1 - Registered Informal: Enterprises register with a simplified national ID system, gaining legal recognition, protection from arbitrary enforcement, and access to a basic digital business account. Limited initial tax and social security obligations will be imposed on these enterprises.

• Tier 2 - Contributing Informal: Enterprises opt into a presumptive micro-tax (flat rate, quarterly, sector-calibrated) in exchange for access to public procurement opportunities, credit guarantee programs, and basic social protection for the owner.

• Tier 3 - Transitional Formal: Enterprises approaching formal viability can enter a two-year transition period with subsidized compliance costs, mentorship, and protected market access before assuming full formal obligations.

This framework acknowledges that formalization is a process, not a binary switch, and creates institutional on-ramps at each stage of enterprise development rather than requiring full compliance before enterprises can assess institutional support.

Recommendation 2: Portable Digital Benefits - Decoupling Protection from Employment

The strong linkage between social protection and formal employment contracts remains one of the key structural limitations of many welfare systems across MENA. In many countries, it leaves a large share of the workforce with limited access to basic social protection, and it makes formalization appear as a cost to workers rather than a benefit. 

MENA governments should pilot a universal portable benefits account, a digital benefits account linked to a national ID rather than a specific employer, into which contributions from any source (worker, informal employer, government, and remittances) can flow, and from which basic health, pension, and unemployment support can be drawn regardless of employment type. Egypt's Mezan digital payment infrastructure, together with Morocco's former RAMED health program and its current AMO system, provide useful building blocks for such an approach.

International experience from India's Unified Payments Interface and Kenya's M-Pesa ecosystem suggests that digital financial infrastructure can dramatically extend social protection reach in contexts of high informality, reducing out-of-pocket vulnerability without requiring labor market formalization as a precondition.

Recommendation 3: Informal Economy Innovation Clusters

Rather than focusing only on integrating informal enterprises into existing formal market structures, MENA governments should consider establishing Informal Economy Innovation Clusters: geographically defined zones where informal enterprises receive a structured package of support while gradually transitioning toward greater institutional engagement.

The cluster model draws on successful precedents from industrial cluster policy but inverts the usual logic: instead of focusing primarily on attracting formal firms through incentives, it extends formal-sector resources to informal firms shared equipment, collective credit guarantees, market access, and skills training in exchange for basic registration (Tier 1) rather than full formalization. This preserves the flexibility of informal enterprise while connecting them to broader institutional support networks.

Recommendation 4: A MENA Informal Economy Data Compact

One of the most fundamental constraints on effective informal economy policy in MENA is the absence of reliable, comparable, disaggregated data. The World Bank's 2023 report on informality and inclusive growth in MENA notes that Egypt, Morocco, and Tunisia each measure informality differently, making regional comparison methodologically challenging and limiting opportunities for policy coordination.

MENA2050 is uniquely positioned to support discussions around a MENA Informal Economy Data Compact; a voluntary commitment among MENA statistical agencies to adopt a common measurement framework aligned with the ILO's updated 21st ICLS standards, and to share disaggregated data on informal employment by sector, gender, age, geography, and enterprise size. Such data infrastructure would provide an important foundation for more evidence-based policymaking.

Recommendation 5: Presumptive Taxation - Making Fiscal Participation Frictionless

Conventional tax policy often approaches informal enterprises primarily through a compliance lens, which can lead to enforcement-oriented responses (inspectorates, penalties, crackdowns) that may struggle to increase long-term participation, and can negatively affect informal enterprise ecosystems . 

A complementary approach is presumptive taxation: flat-rate, sector-calibrated tax instruments that informal enterprises can comply with without maintaining formal accounts or hiring tax advisors. Morocco's auto-entrepreneur regime - which levies a turnover-based flat tax with no accounting requirements - offers a partial model. Egypt's Micro Enterprise Law of 2020 moves in a similar direction. The recommendation here is to deepen and extend these models, reducing the compliance complexity that prevents uptake, and linking participation to concrete benefits (credit access, public contracts, social protection) rather than relying primarily on enforcement measures.

Conclusion

The informal economy is not a policy problem waiting to be solved. It is a governance challenge waiting to be addressed. For three decades, MENA policymakers have often approached the informal economy as a transitional phenomenon, something expected to gradually decline as economies develop, regulations simplify, and institutions strengthen. However, the evidence reviewed in this brief suggests that this expectation requires reconsideration.

The informal economy in MENA is structurally embedded and is unlikely to disappear through traditional formalization approaches alone. It can, however, be engaged more effectively through institutional frameworks that recognize its internal dynamics, extend benefits to its participants without imposing prohibitive compliance costs, and gradually build bridges between informal and formal economic life. Such approaches can allow enterprises and workers to move along a spectrum of economic participation rather than across a rigid binary divide.

The five recommendations in this brief - Graduated Recognition, Portable Benefits, Innovation Clusters, Data Compacts, and Presumptive Taxation - are not a comprehensive agenda. They represent a starting point for reframing the policy conversation in ways that take the informal economy seriously as an institutional reality, while addressing the challenges and opportunities it presents.

MENA policymakers face a strategic choice. They can continue approaching a significant share of their workforce primarily as a policy problem to be managed, or they can recognize those workers, enterprises, and networks as sources of economic potential and build governance systems capable of supporting their development.

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