In a nation where the unregulated market dwarfs the formal economy, millions survive in the margins while the state slowly collapses
By October 2025, Pakistan’s formal economy stood at $407.2 billion a figure announced with cautious optimism by government officials in Islamabad. What they didn’t emphasize, though the numbers tell the story plainly enough, is that lurking behind this official tally is a shadow twice its size. Pakistan’s informal economy, that sprawling underground network of unregistered businesses, smuggled goods, undocumented workers, and untaxed transactions, has grown to an estimated $457 billion. It is not merely an economic phenomenon it is the economy. For every documented rupee earned in Pakistan’s official statistics, another flows through channels the government cannot see, cannot tax, and increasingly, cannot control.
This is the paradox at the heart of Pakistan’s development crisis: a country of 240 million people where 72.5% of the non-agricultural workforce operates in the shadows, where three million businesses remain unregistered, where illicit trade equals 20% of the formal economy, and where the tax-to-GDP ratio a mere 10.2% ranks among the world’s lowest. Pakistan isn’t failing to develop because its people don’t work; it’s failing because the fruits of their labor vanish into an invisible economy that sustains livelihoods while slowly suffocating the nation’s future.
The Anatomy of Invisibility
Walk through Karachi’s massive bazaars, Lahore’s dense commercial districts, or the artisan workshops scattered across Faisalabad’s textile belt, and you’re witnessing Pakistan’s real economy in action. Street vendors selling mobile phones and clothing without sales tax receipts. Small factories operating without registration, paying workers in cash, producing goods that will be sold without invoices. Real estate transactions where buyer and seller agree to dramatically underreport the sale price to dodge stamp duties and capital gains taxes a practice so common that in major cities, up to 70% of property deals involve undeclared black money.
This is the informal economy in its daily operation: not criminal in the traditional sense, not violent, not explicitly malicious, but fundamentally outside the state’s regulatory framework. The shopkeeper who doesn’t register for a sales tax number. The textile manufacturer who underreports production. The property developer who accepts cash payments and doctored valuations. Each individual decision is rational compliance is expensive, complicated, and seemingly pointless when the government provides little in return but collectively, these millions of rational decisions are creating a crisis of state capacity.
The numbers, compiled painstakingly by the Small and Medium Enterprises Development Authority and the International Labour Organization in their landmark 2024 study, paint a stark picture. Of Pakistan’s estimated 5.24 million small and medium enterprises, the vast majority operate informally. Fifty-three percent function in wholesale and retail trade, hotels, and restaurants. Twenty-two percent provide community and personal services. Twenty percent work in manufacturing. These businesses employ 70% of the non-agricultural labor force. They generate approximately 30% of Pakistan’s exports. And they contribute almost nothing to the national treasury.
The scale becomes clearer when examining specific sectors. In tobacco, over 40 manufacturers exist, yet only two multinationals are fully compliant, accounting for 98% of tax revenue in the sector. A 2024 study found that merely 19 out of 264 cigarette brands complied with Track and Trace System regulations, meaning 56% of the market consisted of non-compliant and untaxed products. In pharmaceuticals, approximately 40% of medicines are counterfeit or substandard, causing an estimated Rs 65 billion in revenue loss annually. Over 60% of tires sold in Pakistan are smuggled, resulting in Rs 106 billion in lost government revenue. Even tea a staple consumed in virtually every household sees 30% of its market share captured by smuggling, costing the exchequer Rs 10 billion.
The Afghan Transit Trade facility, designed to allow goods destined for landlocked Afghanistan to pass through Pakistani ports, has become a conduit for massive smuggling operations. Nearly Rs 1 trillion 30% of Pakistan’s total informal economy tax loss is linked to the misuse of this single facility, with goods supposedly in transit somehow finding their way to Pakistani markets instead.
The Fiscal Hemorrhage
For a government, the informal economy isn’t just an administrative inconvenience it’s an existential threat. Pakistan’s fiscal crisis is fundamentally a crisis of the informal economy. When three-quarters of economic activity occurs outside the tax net, when major industries operate with impunity beyond regulatory oversight, when real estate transactions routinely involve massive undeclared cash payments, the state loses the revenue necessary to function.
The magnitude of the loss is staggering. Conservative estimates place annual tax losses from illicit trade at Rs 8 trillion a figure that represents 85% of Pakistan’s tax revenue target for the 2023-24 fiscal year. To put this in perspective, if Pakistan could recover even half of this lost revenue, it could effectively double its public spending on healthcare, education, and infrastructure combined. Instead, the government scrapes together what it can from the narrow formal sector, heavily taxing the salaried class and compliant businesses while the vast informal economy escapes untouched.
The result is one of the world’s most dysfunctional tax systems. Pakistan’s tax-to-GDP ratio of 10.2% places it barely above Laos in Organization for Economic Cooperation and Development rankings far below regional peers like India (16.7%) and grotesquely distant from developed economies like Sweden (above 40%). This isn’t because Pakistan lacks economic activity; it’s because most economic activity is invisible to the state.
The structural distortions this creates are profound. In the first half of fiscal year 2024-25 alone, salaried individuals who constitute only 2% of the labor force bore Rs 243 billion in taxes, with annual burdens projected at Rs 570 billion. Meanwhile, the retail and wholesale sectors, despite contributing nearly 20% to GDP, contribute just 4% to the national tax base. Agriculture, which employs a significant portion of the population, operates largely informally, complicating tax enforcement and resulting in minimal collection. The services sector, dominated by cash-based transactions, systematically evades taxation.
The consequence is that Pakistan’s government operates in a state of permanent fiscal emergency. Debt servicing consumes 45% of federal revenue. With such limited fiscal space, investment in education, healthcare, and infrastructure becomes an unaffordable luxury. Pakistan spends less per capita on health and education than almost any country in South Asia. Its infrastructure, roads, power grids, water systems, deteriorates while the government lacks funds for maintenance and upgrades. The informal economy, in other words, doesn’t just avoid contributing to the national treasury; it actively prevents the state from functioning effectively.
The Multinational Exodus
International corporations are pragmatists. They conduct sophisticated risk assessments, analyzing market conditions, regulatory environments, and competitive landscapes before committing capital. When they look at Pakistan today, they see an economy where the informal sector has grown so large and so entrenched that formal business becomes nearly impossible.
The exodus began gradually, then accelerated. In recent years, major multinationals have shuttered operations or dramatically scaled back their Pakistani presence: Shell, Eli Lilly, Microsoft, Uber, Yamaha, TotalEnergies, Telenor. In 2024, Procter & Gamble ceased manufacturing in Pakistan, transitioning to third-party distribution. By mid-2024, Akzo Nobel, the Dutch paint giant behind Dulux, announced its full exit from the country, selling operations to a local firm. Over two dozen major companies have reduced their footprint or departed entirely since 2020.
The stated reasons vary, currency volatility, energy costs, political instability, but underlying each decision is the same calculation: Pakistan’s informal economy makes formal business unviable. How can a multinational pharmaceutical company compete when 40% of medicines in the market are counterfeit products manufactured in unregistered facilities? How can a paint company maintain margins when informal competitors operate without paying corporate taxes, sales taxes, import duties, or compliance costs? How can any formal manufacturer compete against smuggled goods that enter the country duty-free through corrupted border management?
The answer is they cannot, or rather, they can only by accepting razor-thin margins that make continued investment irrational. Foreign direct investment in Pakistan remains stubbornly low among the worst in South Asia. International investors cite not just standard developing-country challenges like infrastructure deficits or political uncertainty, but the fundamental unfairness of a system where formal businesses must compete against informal operators who face none of the costs of compliance.
The Pakistan Business Council, representing the country’s largest businesses, has documented how illicit trade, smuggling, under-invoicing, counterfeiting, accounts for approximately $68 billion, or 20% of the formal economy. For companies trying to operate legally, this creates an impossible competitive environment. Formal businesses pay corporate taxes, sales taxes, import duties, employee benefits, environmental compliance costs, all while competing against informal operators who pay none of these. The playing field isn’t merely uneven; it’s vertical.
The impact on Pakistan’s economic complexity has been severe. The country’s Economic Complexity Index ranking remains stuck at the same level it held in 2000. Exports have stagnated. Manufacturing output has declined. Technology transfer from multinationals has slowed to a trickle as companies reduce their Pakistani commitments. Local firms may acquire the scraps, as IGI Holdings did with Akzo Nobel’s operations—but they rarely possess the global expertise, technical capabilities, or international connections that multinationals bring.
The Social Cost: Millions Outside the Safety Net
For all the macroeconomic implications, the human dimension of Pakistan’s informal economy is perhaps most striking. Over 85% of jobs remain informal, positions without contracts, without social security, without health insurance, without retirement benefits, without legal protections. To work in Pakistan’s informal economy is to live perpetually on the edge of economic catastrophe.
Consider the daily realities. Informal workers, street vendors, day laborers, workshop employees, domestic workers, typically earn wages that place them just above or sometimes below the poverty line. According to World Bank data released in June 2025, approximately 45% of Pakistan’s population lives below the poverty line, with extreme poverty rising from 4.9% to 16.5%. Over 10 million additional individuals face imminent risk of descending into poverty. The informal economy sustains these millions, yes, but it sustains them in precarity.
When informal workers fall ill, they have no health insurance. When they grow old, they have no pension. When economic shocks strike, inflation spikes, floods, pandemics, they have no safety net. The COVID-19 pandemic demonstrated this vulnerability starkly. When lockdowns struck, informal sector employment vanished overnight. Jobs that could be suspended with no notice because they had never been formally created in the first place simply disappeared. Incomes plummeted. The national poverty rate surged to 24.7%. Urban areas, where informal employment is particularly concentrated, suffered immensely.
The longer-term developmental costs are equally severe. Nearly 40% of Pakistan’s children are stunted, a direct indicator of chronic malnutrition. One-quarter of primary-school-aged children are out of school entirely. Of those who do attend, 75% cannot read and understand a simple story by the end of primary cycle. These appalling education and health outcomes are directly linked to the informal economy: when the state lacks tax revenue, it cannot fund schools or health clinics; when parents work in informal jobs with irregular income, they cannot afford to keep children in school or provide adequate nutrition.
Infrastructure deficits compound the problem. Only half of households have safely managed access to drinking water. Thirty-one percent lack safe sanitation. Roads are poorly maintained, particularly in rural areas, making access to whatever services do exist difficult or impossible. For girls, the impact is particularly severe: if a road is more than 5 kilometers away, the probability of being out of school is 76% higher than for boys.
The informal economy, in other words, doesn’t just deprive the government of revenue; it traps millions of Pakistanis in a cycle of poverty, poor education, inadequate healthcare, and economic vulnerability that reproduces itself across generations.
The Vicious Cycle: Why Formalization Fails
Economists and policymakers in Islamabad periodically announce ambitious plans to “document the economy,” to bring informal businesses into the formal sector. They mandate Point-of-Sale systems for retailers, they launch trader registration schemes, they implement Track and Trace systems for high-value goods. And yet the informal economy persists, growing even as formal GDP stagnates. Why?
The answer lies in the vicious cycle that has entrapped Pakistan’s economic system. High compliance costs drive businesses informal; informal competition then makes formal operation even more difficult; this reduces government revenue; reduced revenue means worse public services; poor services justify tax evasion; and more businesses conclude that informality is the only rational choice.
Start with the formal sector’s burdens. Pakistan’s tax system is notoriously complex, with multiple overlapping levies administered by different authorities. Compliance requires navigating Byzantine bureaucratic procedures, often involving arbitrary inspections and rent-seeking officials. A study by Lahore University of Management Sciences found that of every Rs 100 in taxes that should reach the government, only Rs 38 actually arrives, the remainder pocketed by taxpayers, tax collectors, and tax practitioners through corruption and evasion.
For small and medium enterprises, the calculation is stark. Registering formally means accepting a corporate tax burden, sales tax collection responsibilities, import duties, employee benefit mandates, environmental regulations, and constant engagement with regulatory authorities. In return for these costs, businesses receive... what, exactly? Certainly not reliable electricity, Pakistan’s energy sector remains mired in crisis, with frequent outages and soaring tariffs. Not functioning courts, the legal system is slow, overburdened, and often corrupt. Not adequate infrastructure, roads crumble, ports are inefficient, logistics costs are among the highest in Asia. Not protection from unfair competition, the government demonstrably cannot stop smuggling or counterfeit goods.
Small wonder, then, that businesses choose informality. Not out of some moral failing or cultural predisposition toward lawlessness, but because formalization means accepting crushing costs while receiving minimal benefits. The trader who registers pays 18% sales tax while his informal competitor next door pays nothing and still serves the same customers. The manufacturer who reports accurate production figures watches smuggled goods undercut his prices. The pharmaceutical company that invests in proper facilities competes against counterfeit medicines manufactured in unregistered factories.
Recent policy moves have, perversely, made the situation worse. While non-Tier 1 retailers can now pay a flat 2% as full and final tax for digital transactions, formal Tier 1 businesses must suffer 18% GST, literally penalizing those who have already chosen formalization. The withholding tax on services was raised from 11% to 15%, making formal service provision even less competitive. Policy volatility itself becomes a driver of informality: when tax rules shift unpredictably, when amnesty schemes periodically whitewash black money, when enforcement campaigns launch and then peter out, rational businesses minimize their visibility to the state.
Corruption intertwines with every level of this system. Tax officials collude with businesses, accepting bribes to ignore under-invoicing, unreported income, and fictitious expenses. Customs officers facilitate smuggling. Police protect illegal operations. This isn’t merely individual malfeasance; it’s systemic capture, where the informal economy has grown so large that it can afford to purchase protection from enforcement.
And because the informal economy operates outside regulatory oversight, it generates none of the data that modern economies require. Banks cannot assess creditworthiness when potential borrowers have no documented income. Investors cannot evaluate market opportunities when production, sales, and employment figures are unreliable. Policymakers cannot design effective interventions when they don’t know the true scale or distribution of economic activity.
The Digital Mirage
In 2025, as in previous years, Pakistani officials continue to tout digitalization as the solution to informality. Prime Minister Shehbaz Sharif has called for “full digitization of the economy.” The Digital Nation Pakistan Act 2024 established new bureaucratic bodies, the National Digital Commission, the Pakistan Digital Authority meant to coordinate digital transformation. The government mandates Point-of-Sale systems, pushes mobile banking, promotes fintech platforms like Raast, Easypaisa, and JazzCash.
The statistics initially seem impressive. Digital transactions surged 35% in 2024, rising from 4.7 billion to 6.4 billion. Raast has attracted 20 million users. Mobile banking infrastructure is expanding, particularly in underserved regions. These are real achievements, genuine steps toward creating a more transparent, traceable economy.
But digitalization alone cannot solve Pakistan’s informality crisis, for a simple reason: the informal economy exists not because people lack access to digital payment systems, but because formalization is economically irrational. You can mandate that a shopkeeper install a Point-of-Sale system, but if his formal competitors next door operates without one and undercuts his prices, what have you achieved? You can create a Track and Trace system for cigarettes, but if counterfeit stamps are widely available and enforcement is lax, as the 2024 study showing only 19 compliant brands out of 264 demonstrates the system fails.
Moreover, digital adoption remains severely uneven. Rural areas, where much of the population lives, often lack reliable internet connectivity. Digital literacy is low, particularly among older workers and those with limited education. Smartphones, while increasingly common, are still beyond the means of the poorest Pakistanis. The digital infrastructure, in other words, is being built atop a foundation of structural inequality and institutional dysfunction.
The deeper problem is that digitalization addresses symptoms rather than causes. It can make transactions more traceable, but it doesn’t address why businesses avoid the formal sector in the first place. It doesn’t reduce compliance costs, or improve public services, or stamp out corruption, or create a level playing field between formal and informal operators. Until those fundamental issues are addressed, digitalization becomes merely another burden that formal businesses must bear while informal competitors ignore.
What Is to Be Done?
Pakistan’s informal economy didn’t emerge overnight, and it won’t disappear quickly. It is the product of decades of institutional failure, policy dysfunction, and eroding state capacity. Addressing it requires not technical fixes or digital platforms, but fundamental reforms that acknowledge an uncomfortable truth: the informal economy persists because, for millions of Pakistanis, formality is simply not worth it.
Any serious reform agenda must begin with making formalization economically rational. This means dramatically simplifying Pakistan’s tax code, reducing rates to levels that businesses can actually afford, and streamlining compliance procedures. It means fixing public services, providing reliable electricity, maintaining infrastructure, reforming the judiciary, so that formal businesses receive tangible benefits in exchange for their tax payments. It means creating a level playing field by actually enforcing regulations against smuggling, counterfeiting, and illicit trade, rather than periodically launching crackdown campaigns that fade away.
It requires building trust between citizens and the state, perhaps the most difficult task of all in a country where corruption is endemic and government services are abysmal. When citizens believe their taxes vanish into bureaucratic pockets or are wasted on inefficient state enterprises, they will continue avoiding the tax system. Trust can only be rebuilt through demonstrated improvements in governance: transparency in how revenues are spent, accountability for corruption, visible improvements in public services.
The international dimensions matter too. Pakistan’s location makes it vulnerable to smuggling, particularly through the Afghan border. Controlling illicit trade requires not just better customs enforcement but regional cooperation, improved border management, and addressing the underlying factors, currency flows, money laundering networks, official complicity, that enable smuggling to thrive.
Perhaps most fundamentally, Pakistan needs to stop treating the informal economy as a moral failing to be corrected through enforcement and documentation campaigns. The informal economy is a rational response to dysfunctional institutions. People aren’t avoiding formality because they’re irresponsible or criminal; they’re avoiding it because formality doesn’t work. The state’s task isn’t to force compliance through coercion, an approach that has failed repeatedly, but to make formalization attractive by actually delivering the governance that formal status should entail.
Conclusion
As October 2025 draws to a close, Pakistan finds itself at a crossroads. The formal economy, at $407.2 billion, has grown modestly, 3.04% in the most recent fiscal year. Officials speak cautiously of macroeconomic stabilization, of industrial recovery, of gradual improvements. But underneath these official statistics, the shadow economy continues its parallel expansion, now estimated at $457 billion and growing.
This isn’t sustainable. A state that can tax only 10% of GDP cannot provide basic services. A formal sector competing against an informal economy twice its size cannot attract investment or generate quality employment. Millions of workers trapped in informal, precarious jobs cannot escape poverty or build better lives for their children. And a government that loses Rs 8 trillion annually to tax evasion cannot reduce its crippling debt burden or invest in the human capital and infrastructure that development requires.
The longer Pakistan delays addressing the root causes of informality, the crushing compliance costs, the dismal public services, the rampant corruption, the fundamental unfairness of forcing a minority to bear the fiscal burden while the majority escapes, the deeper the crisis becomes. Businesses that might formalize choose not to. Multinationals that might invest choose elsewhere. Young professionals who might build their careers in Pakistan choose emigration instead. The gap between what Pakistan is and what it could be grows wider.
Pakistan’s informal economy is not an exotic feature of developing-country economics or a temporary phase in modernization. It is a crisis of governance, a symptom of institutional collapse, and a barrier to any vision of development or prosperity. Until Pakistan’s leaders confront this reality, not with digitalization schemes or documentation mandates or periodic crackdowns, but with fundamental reforms that make formality worth the cost, the shadow economy will continue to grow, and the Pakistani state will continue to wither.
In Karachi’s bazaars and Lahore’s markets, in Faisalabad’s workshops and Islamabad’s real estate offices, millions of Pakistanis will continue their daily economic activity. They will buy and sell, produce and consume, employ and earn. But the state, struggling with debt, unable to fund schools or hospitals, watching multinationals depart and tax revenues stagnate, will remain largely invisible to this real economy. And Pakistan’s future, like so much of its present, will unfold in the shadows.
Data current as of October 22, 2025, compiled from National Accounts Committee reports, Pakistan Bureau of Statistics, Small and Medium Enterprises Development Authority studies, International Labour Organization research, Pakistan Business Council analyses, and State Bank of Pakistan economic surveys.