From the margins to the mainstream: Latin America’s informal economy

Firms that stay informal cannot scale or borrow affordably¹² while workers forgo fair wages, social protection and credit histories.¹³ Economies with high informality generate barely a third of the GDP per capita seen in more formal peers.¹⁴ Raising women’s labor force participation to Nordic levels could deliver major economic gains across Latin America, adding as much as $208.8bn to Mexico’s economy alone, according to the Milken Institute think tank.¹⁵ With large shares of labor and capital beyond the reach of policy, monetary signals falter and tax receipts leak away. This all results in a dual economy. One modern, connected and investible; the other invisible and under-banked. For investors, that split complicates risk assessment but also reveals a vast market of untapped potential.

From shadow to scale

The most effective formalization drives ensure that procedures are simple, compliance costs are low and the rewards of joining the formal economy outweigh those of staying outside it. Bridging that gap requires both better access and stronger incentives.

Nudges that work

Bureaucracy must be reduced. A recently formalized firm may struggle to survive if regulations are burdensome. Simplifying registration and tax compliance lowers the hurdle for micro-entrepreneurs to formalize without sacrificing flexibility.¹⁶ The improvement of government services for SMEs and access to commercial and professional infrastructure are also attractive draws. In Brazil, the Microempreendedor Individual (MEI) scheme has registered over 15m micro-entrepreneurs since 2008 by offering a simple online sign-up and a fixed monthly contribution. The scheme provides participants access to health and pension benefits, low-cost credit, digital invoicing and eligibility for government tenders, helping small traders graduate into the formal economy. Costa Rica’s digital one-stop business portal likewise centralizes procedures and speeds incorporation, reducing the friction that usually keeps enterprises off the books.¹⁷

While regulatory simplification is largely a state function, investors can shape the process by financing the tools and intermediaries that make formalization cheaper and faster. Such models are already emerging. Colombia’s regulatory sandbox and Chile’s fintech-friendly policies facilitate innovation in financial services and reduce regulatory cost burdens.¹⁸ Investors in these ecosystems gain exposure to new customer segments as more businesses enter the formal system.

Small, creative incentives can also shift behavior toward formality. Countries such as Argentina, Brazil, Colombia, Mexico and Paraguay run schemes that reward consumers for requesting invoices through prize draws. In Santa Fe, Argentina, a property-tax lottery offering sidewalk construction prizes made winners 7% more likely to pay taxes on time for three years and even boosted compliance by 7.5% among their neighbors.¹⁹

Expanding access to education and entrepreneurship training can likewise pull workers to formalize, especially when public initiatives are matched by private-sector investment. Partnerships between governments and investors that fund vocational training and business-development programs not only raise human capital but also build formal business pipelines. Countries improving such programs see measurable declines in informality, about 0.2 percentage points of GDP within five years of major gains in training and schooling.²⁰

Technology as an enabler

Technology is the engine driving Latin America’s shift from shadow to scale, expanding financial inclusion and extending services to underserved communities. Real-time payment (RTP) infrastructure is reshaping Latin America’s financial landscape, replacing cash-dominated transactions with transparent and low-cost alternatives.²¹ Mexico’s SPEI, Argentina’s Transferencias 3.0 and Colombia’s Bre-B network are making instant, interoperable digital payments the regional standard. Brazil’s instant-payments rail, Pix, led to cash’s share of transactions falling from about 42% in 2020 to 22% in 2023, and now eclipses cards in volume.²² For lenders and processors, the digital shift generates valuable transaction data for credit scoring and production innovation.

Latin America’s fintech market is expanding rapidly with more than 3,000 startups in 2023 (a cumulative growth of 336% since 2017), driving innovation in payments and lending as bank-fintech partnerships proliferate.²³ As interoperability deepens, fintechs and banks can build layers of value on top of national RTP backbones, from merchant payments and payroll solutions to consumer credit and micro-insurance. The potential remains vast. Eight in ten MSMEs in Latin America remain at a basic level of digitalization, according to the Organizational Digital Maturity Index, and only one in ten is transformative, leaving ample space for fintechs to accelerate their digital and financial inclusion.²⁴ Business leaders would do well to put the financial sector’s impending transformation at the top of their agenda, seeking market solutions that streamline payments and collections, cut costs and improve working-capital returns.

The meteoric rise of Colombia’s Rappi shows how instant-payment rails enable embedded finance at scale, lowering transaction costs and expanding reach to the unbanked. What began as a delivery platform has evolved into a $5.25bn super app with more than 3 million users and a 50% market share.²⁵ Since gaining regulatory approval as a financial entity in 2022, RappiPay and RappiBank have delivered more than 215,000 credit cards across Colombia and accumulated 300,000 savings account customers, offering a country-high 14% interest rate.²⁶

By widening the funnel for credit and decreasing financial costs, the divide between informality and inclusion begins to narrow. With smartphones outrunning traditional banking, digital IDs and interoperable wallets create low-cost gateways into the formal economy. In a region where account ownership has surged and real-time payments are mainstreaming, the next leg of value lies in building the infrastructure—financial and regulatory—that turns informal hustle into formal growth.

Integration without exclusion

Formalizing Latin America’s vast shadow economy represents a growth opportunity rather than a bureaucratic hurdle. As simpler business registration platforms and fintech innovation take hold, the divide between informality and inclusion is beginning to narrow. There is opportunity in scale as every cash transaction converted and every unbanked worker connected expands the market and strengthens fiscal and financial resilience. As payments infrastructure becomes more open and contestable, firms that embrace digital tools will tap new customers, richer data and cheaper capital. Those that cling to the informal, analogue past will be left competing on ever-thinner margins. Investors who support this transition, from mobile payments to SME credit platforms, stand to benefit from a region moving from volatility toward visibility.