The “Informal Sector” in AfricaJune 1 and 3, 2010 ECON 3510

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This section is not in the text book. Please take notes to flesh out this

summary.

Outline1. 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

Kenya: Rural Market

1. Some Description– Presence everywhere– Variation among Countries– Diversity or “Heterogeneity” 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

The Informal Sector in KenyaNon-Farm Economic Activities in Rural Households.

Kenya, circa 1979

Number of Non-Farm Activities per Sample

Household

Western Province

National

012345

6 or more

44.332.811.84.03.11.52.5

49.626.413.04.72.51.32.4

Total 100.0 100.0

Informal Employment in Non-Agricultural Employment for Africa

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 93Guinea 74 87 66 95Kenya 72 83 59 42South Africa

51 58 44 25

Sub-Saharan Africa,

72 84 63 70

Source: ILO, Men and W\omen in the Informal Economy, Geneva, 2002 pp 19-20

Past Theorizing regarding the Potential Role of the informal SectorOlder Views:

Adam Smith: Normal activity; purely competitive

Karl Marx: Replace with large scale industry and organization; “lumpen proletariat”

Socialist Theorizing:Replace it; Central Planning; Economies of Scale; Collectivization

Mainstream “Development Economics” 1945-1972Small Enterprise Usually Ignored

– Rostow, Lewis, – 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, focussing on Ghana; • ILO, 1970s, Study in Kenya; • Parallel interest in Underground Economies of

Western countries [“Shadow Economies”]• Hernan DeSoto, 1989 re Peru;• 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 & Vital

+++ Legal

Underground or Shadow Economy

+ (Process); -ve (Tax

Avoidance)

+ Usually Legal

Criminal Economy --- Illegal Totally Illegal

The Range of Economic Activities and their Place in GDP Measures

Product Legality of Product

Legality of Production Process

Inclusion in “GDP” Reasons for Exclusion

“Formal Sector” or Economy

Legal products of all varieies

Yes

Yes Underground provision for

some activities

Yes No for some

activities

n.a.

Tax Evasion

“Informal Sector” or Economy

Many types of services, usually small scale

Yes Yes

Often No Yes in LDCs for

Main IS Activities

Excessive costs of gathering information Some tax evasion

Home-Based Economic Activities

Child-care; Home maintenance and repair, Food preparation, Personal Services

Yes

Yes

No

Value impossible to determine accurately Tax collection unrealistic

Criminal Activities

Drugs, Prostitution, Gambling of some sorts; Extortion rackets

No

Yes; Maybe yes Maybe no;

No

No

Activities are illegal; Relevant Information

impossible to determine

Origins and Roots of Informal Economy

Why does it exist?

Origins and Roots of Informal Economy

1. Traditional and often Pre-Colonial Economy and Society,

e.g. African traditional economic activities ….

2. Slow Growth of Employment in the Formal Economy

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

3. 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 BusinessCountry Number of

ProceduresTime Required,

DaysCost 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

– Taxation Levels– 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

4. Informal Sector as a Social Safety Net

Comparison of “Formal” and “Informal Sectors”

Characteristics “Informal Sector” “Formal” Sector

Ease of EntryEase of EntryResource UseOwnershipScale of OperationTechnologyOrganizationIncome

Low Barriers Low Barriers to Entryto EntryLocal ResourcesFamily OwnershipMicro to SmallLabour IntensiveSimplerVariable; from sales

High Barriers High Barriers to Entryto EntryForeign Resources Often Foreign Medium to LargeCapital IntensiveBureaucraticFormal Wages

Skill Acquisition Outside the School System (Informal Apprenticeship)

Formal Educational System

Labour Market Competitive and Unregulated

Uncompetitive and Regulated

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

Informal Economy

Formal Economy

Taxation

Regulation

Untaxed except for Licensing

Mainly 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, R&D support….)

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 Entrepreneurship6. 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. Health & safety standards ignored3. Environmental laws & regulations ignored4. “Self-exploitation” ? ?5. Child labour6. Links with criminal economic activities

sometimes7. 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:

– Low cost licensing– Security of tenure– Physical security– MICROCREDIT – Basic training e.g. in book-keeping– Technical extension services– Public provision of infrastructure (market stalls, water,

electricity)

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

regulation

Potential Contribution of the Informal Economy 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-oaying and acceptance of regulations

5. Improved environmental standards

Potential Contribution of the Informal Economy for Future Development??

7. Better jobs and higher incomes8. Increased generation of Savings and

Investment9. Foreign Exchange generation and savings

(continued domestic Value Added using domestic inputs rather than imported input)

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

12. Low productivity activities will evolve into higher productivity activities or else disappear.

Potential Contribution of the Informal Economy for Future Development??

Potential Contribution of the Informal Sector for Future Development

– Last resort activities that will diminish and disappear with the expansion of the formal economy?

– A foundation for future enterprise development and economic improvement?