The informal sector in China: The role of institutional reform and digital transformation on enterprise formalization

This paper examines the dynamic evolution of economic informality in China along two dimensions: business registration (the extensive margin) and formal labor protections within registered firms (the intensive margin). Leveraging administrative records alongside micro-survey data from OSOME (2020–2026) and ESIEC (2018 and 2025), we evaluate how institutional reforms and digital transformation shape formalization incentives. While market-oriented regulatory reforms—such as the landmark 2014 business registration reform—fueled an unprecedented expansion in formal enterprise creation, stringent labor regulations unintentionally inflated intensive-margin informality. Simultaneously, the rapid rise of digital platforms and fintech ecosystems has created a platform substitution effect, enabling micro-enterprises to access credit, build consumer trust, and operate flexibly without state licenses. Consequently, we observe an informality paradox: extensive-margin informality remains widespread and is counterintuitively higher in China's most developed, highly digitized cities.