If a labor market is the place where individuals sell their human and physical capital to firms, with wages set by supply and demand, informal labor markets are, broadly speaking, those in which this process is not overseen by, or does not comply with, the rules set by the relevant regulatory authority. However, the exact definition remains under debate, despite decades of research and academic argument (Maloney 2004). As Peattie (1987) quotes from Schaefer (1976), “the informal sector is still too broad to be meaningful; at one end is a pool of surplus labor, at the other a skilled high‐income earning entrepreneur; at one end a proliferation of residual enterprises involuntary in nature, at the other end of the spectrum dynamic evolutionary enterprises.” As a result, throughout the past century several competing theories appeared, in an attempt to explain what informal labor markets are, and also why they exist.

The informal economy is, broadly speaking, the fraction of the economy not overseen by or not complying with the rules set by the relevant regulatory authority, namely the state. However, the exact definition remains under debate, despite decades of research and academic argument. As Peattie says, “the informal sector is still too broad to be meaningful; at one end is a pool of surplus labor, at the other a skilled high‐income earning entrepreneur; at one end a proliferation of residual enterprises involutionary in nature, at the other end of the spectrum dynamic evolutionary enterprises.” Generally speaking, the size of the informal economy has been linked to issues such as taxes, regulation, and the size of labor supply, among others.