The “Informal Sector” in AfricaMay 27 and 29, 2014

ECON 3510, Arch Ritter

Source: Class Notes

Outline

1. Some Description2. Past Theorizing3. Definition of the Informal Sector4. Origins and Roots of Informal Economy5. Comparison of “Formal” and “Informal

Sectors”6. Impacts of the Informal Sector on the

National Economy and Society7. Public Policy and the Informal Sector

Artisanal Mining, Tanzania

1. Some Description– Presence everywhere– Variation among Countries– Diversity of Informal Enterprise within

countries•High-end to low-end•Sophisticated to “last resort” enterprise

– Rural and Urban IS– Men, Women and Children in the Informal

Sector

Informal Employment in Non-Agricultural Employment for Africa, circa 2000

Country Informal Labour Force as % of Total

Non-Ag. L.F. Women Men

Self -Employment as % of Total

Informal Employment

Benin 93% 97% 87% 95%Chad 74 95 60 93Liberia 78.5%Guinea 74 87 66 95Kenya 72 83 59 42S. Africa 51 58 44 25Sub-Saharan Africa, 72 84 63 70Source: ILO, Men and W\omen in the Informal Economy, Geneva, 2002 pp 19-20

Quantitative Significance of the Informal Economy: The Case of Liberia

Category Number Category NumberTotal Employment 1,278,477Open Unemployment 83,323

(5.7%)

Formal Sector

AgricultureIndustryServicesOther

231,584(15.8%)

34,9499,026

141,63943,162

Informal Sector

AgricultureIndustryServicesOther

1.146.893(78.5)

642,26016.460

114.689367.006

World Bank, Liberia: Employment and Pro-Poor Growth, November 19, 2010

Liberia: Employment Status,Percentage of total

Urban Rural TotalPaid Employee 22.8 11.2 17.0Self-Employed with employee

3.9 1.6 2.1

Self-Employed without employee

31.1 32.5 32.1

Unpaid Family Worker 29.9 53.9 47.8Domestic Employee 1.1 0.7 0.8Apprentice 0.6 0.0 0.2Total 100.0 100.0 100.0

World Bank, Liberia: Employment and Pro-Poor Growth, November 29, 2010

The Significance of the Informal Sector: The Kenyan Case

Non-Farm Economic Activities in Rural Households. Kenya, circa 1979

Number of Non-Farm Activities per Sample

Household

Western Province

National

012345

6 or more

44.332.811.8

4.03.11.52.5

49.626.413.0

4.72.51.32.4

Total 100.0 100.0

Past Theorizing regarding the Potential Role of the Informal Sector

Older Views:Adam Smith: Normal activity; purely

competitive; preferable to monopoly

Karl Marx: Replace the activities with large scale industry and organization;

- A backward “lumpen proletariat”

Socialist Theorizing:Replace it; Central Planning; Economies of

Scale; Collectivization

Past Theorizing regarding the Potential Role of the informal Sector

Mainstream “Development Economics” 1945-72Small Enterprise Usually Ignored

– W. W. Rostow, – W.A. Lewis, – Raul Prebisch, – Capital-Centred Theorizing, – Dependency Theorizing …

Some Voices in the Wilderness:– Indian Cottage industry,– Community Development Theorizing

The Informal Sector Gets Discovered!

•Keith Hart, 1972, focusing on Ghana;

•ILO, 1970s, Study in Kenya;

•Parallel interest in Underground Economies of Western countries [“Shadow Economies”]

•Hernan DeSoto, 1989 re Peru;

The Informal Sector gets Discovered!•Underground Economies in Centrally

Planned Economies get ‘discovered’ , 1980s [“Second Economies,” ]

•Informal Economy and Underground Economy in Transitional Countries (E.Europe and former Soviet Union)

Definition of the Informal Sector based on Institutionalization and Legality

Area of the Economy Process of Production or Distribution

Final Product

Formal Economy +++ Legal +++ Legal Household Economy (for

home use)

Informal Economy (sometimes home-based)

+++ Legal

+/- “Extra-Legal”

+++ Legal and Vital

+++ LegalUnderground or Shadow

Economy+ (Process);

- ve (Tax Avoidance)

+ Usually Legal

Criminal Economy --- Illegal ---Totally Illegal

Origins and Roots of Informal Economy

Why does it exist?

Origins and Roots of Informal Economy

1.Normal Out-growth and accompaniment tp Home-based economic activities2.Traditional and often Pre-Colonial Economy and Society,

e.g. African traditional economic activities …. Mixing with modern types of activities as well

3. Slow Growth of Employment in the Formal Economy

(due to excessive capital intensity, economic stagnation ……….)

4. State Controls and Bureaucratic Regulations– Note differences among various types

of societies and economic systems. •- Hernando De Soto: “The Other

Path”– Registration Blockages

Registration Blockages: Starting a Formal Business

Country Number of Procedures

Time Required, Days

Cost as % of Per Capita Income

Burundi 11 43 215.%Kenya 12 30 40.0South Africa 6 22 6.0Tanzania 12 29 41.5Zambia 6 18 28.6Zimbabwe 10 96 432.7Sub-Saharan Africa

10 46 111.4

Canada 1 5 0.5%

World Bank, WDI 2009, pp. 276-278

4. State Controls and Bureaucratic Regulations, continued:– Regulations

• Labour Laws , • Health & Safety Regulations, • Minimum Wage Legislation, • Environmental controls and rules• Zoning Regulations

– i.e. some IS entrepreneurs may prefer to remain “informal” to evade regulations and taxation

– Greater relevance for middle-income countries

5. Informal Sector as a Social Safety Net

• “Last resort” activity for those with no better alternative, and no other safety net

• Low “Barriers to Entry” permit almost anyone to find some income earning activity– Examples in Liberia: street vending of basic foods;

scratch card venders, soap venders and other street retailers;

Result: Low productivity, near subsistence income

Comparison of “Formal” and “Informal Sectors”

Characteristics “Informal Sector”

“Formal” Sector

Ease of Entry

Resource UseOwnershipScale of

OperationTechnologyOrganization

Income

Low Barriers to Entry

Local ResourcesFamily Ownership

Micro to SmallLabour IntensiveSimpler

Variable; from sales

High Barriers to Entry

Foreign Resources Often Foreign

Medium to LargeCapital IntensiveBureaucratic

Formal Wages & Profits

Comparison of “Formal” and “Informal Sectors” continued

Characteristics “Informal Sector”

“Formal” Sector

Skill Acquisition Outside the School System (Informal Apprenticeship)

Formal Educational System

Labour Market Competitive and Unregulated

Uncompetitive, (maybe unionized) and Regulated

Comparison of “Formal” and “Informal Sectors”, continued

Characteristics Informal Economy

Formal Economy

Taxation

Regulation

Untaxed except for LicensingMainly Unregulated

Taxed

Highly Regulated (Labour legislation, minimum wage, health and safety, environmental)

Public Policies Unprotected and unassisted

Protection and Assistance (credits, trade protection, infrastructure investment,

The Positives: What are they

The Negatives: What are they

On Balance,

Impacts of the Informal Sector on the National Economy and Society

The Positives:1. Production of low-cost goods and

services mainly for low income people2. Job Creation3. Income Generation4. Social Safety net function5. Development of Entrepreneurship

Impacts of the Informal Sector on the National Economy and Society

The Positives, continued:6. Training: informal apprenticeship

systems7. Domestic Value Added (using domestic

inputs rather than imported inputs)8. Appropriate Technology?9. Foreign Exchange generation10. Generation of Savings and

Investment

Impacts of the Informal Sector on the National Economy and Society

Impacts of the Informal Sector on the National Economy and Society (Continued)

The Negatives:1. Tax avoidance and evasion2. Low productivity and low incomes in “Last

Resort” activities3. Minimal prospects for improvement in some

low level “Last Resort” activities4. Health & safety standards ignored5. Environmental laws & regulations ignored

Impacts of the Informal Sector on the National Economy and Society (Continued)

The Negatives, continued:6. “Self-exploitation” ? ?7. Perhaps Child labour; reduced access to

learning8. Links with criminal economic activities

sometimes9. Irreverence and non-compliance with some

concerns of the state.

Public Policy and the Informal Sector?

Should governments do anything in support of micro and small enterprises?

Why or why not?

What types of public policy would be relevant?

Public Policy and the Informal Sector?

Possible Supportive Policies:

1.Low cost licensing2.Security of tenure3.Physical security4.Micro-credit5.Basic training e.g. in book-keeping6.Technical extension services

Public Policy and the Informal Sector?

Possible Supportive Policies, continued:

7. Public provision of infrastructure (market stalls, water, electricity)

8. Encouragement to “graduate” to “formality”? – But note aversion to paying taxes and

government regulation

Potential Contribution of the Informal Economy for Future Development??

Replace it? OR

Can it be a Foundation for Future Development?

1. Development of Entrepreneurship: transferrable to other sectors and up-graded enterprises

2. Training: gradual up-grading of skills?3. Steadily increasing productivity leading to

higher incomes, one hopes 4. “Graduation” of enterprises, into the

formal economy, with tax-paying and acceptance of regulations

5. Improved environmental standards

Potential Contribution of the Informal Economy for Future Development??

7. Better jobs and higher incomes in future

8. Increased generation of Savings and Investment

9. Foreign Exchange generation and savings (continued domestic Value Added using domestic inputs rather than imported input)

Potential Contribution of the Informal Economy for Future Development, continued ??

10.“Last resort” activities will diminish and disappear with the expansion of the formal economy – one hopes…….

12. Many low productivity activities will evolve into higher productivity activities or else disappear.

Potential Contribution of the Informal Economy for Future Development, continued??

The Informal Sector and Future Development:

Two concurrent future scenarios:A.Some “Last resort” and “dead end” activities will

diminish and disappear with the expansion of the formal economy and general increases in incomes, hopefully.

B. Other activities will evolve, improve and “graduate”. Thence, they should help to provide a foundation for

future enterprise development and economic improvement