University of California at Berkeley

Monday October 28rd 2013

Conceptualizing the informal Sector: Analysis and Application in

Africa

By

Ahmadou Aly MBAYE

(University Cheikh Anta DIOP of Dakar)

DISTRIBUTION OF GDP BY SECTOR

 

SHARE OF VALUE ADDED CONTRIBUTED BY INFORMAL BUSINESSES IN THE

SECONDARY SECTOR: BENIN

DISTRIBUTION OF EMPLOYMENT BETWEEN FORMAL AND INFORMAL SECTORS

  Benin (2005) Burkina Faso (2005) Senegal (2003)

  workforce% Share workforce

% Share workforce

% Share

Labor Force

2,811,753  

5,077,926  

3,513,104  

Employment in the public sector including state-owned enterprises 73,106 2.6% 218,351 4.3% 62,885 1.8%

Employment in the formal private sector 59,047 2.1% 50,779 1.0% 214,651 6.1%

Employment in the informal sector

2,668,354 94.9%

4,808,796 94.7%

3,235,217 92.1%

Source : DPS 2003. INSAE 2005. INSD (QUIBB 2005)

PROBLEMS WITH DEFINITIONS AND DATA COLLECTION STRATEGIES

Quite remarkably and unaccustomedly for our profession, the widespread discussion about informality is proceeding without an agreed-upon definition of the term. Even more astonishingly, the field seems to have reached agreement that informality means different things to different people. Empirical studies show only a limited degree of overlap between those workers classified as informal according to the various definitions.” Fields (2011).

“Any researcher studying the informal sector should begin by defining informality”. Kanbur (2009)

“Different countries and regions exhibit distinct patterns of informality. Because of this, generalizations about the causes and consequences of informal employment should be approached with caution….. Just as informal activities exhibit enormous diversity, there is no single archetype of patterns of informality that fits all countries and regions.” Heintz (2012)

PROBLEMS WITH DEFINITIONS AND DATA COLLECTION STRATEGIES

The ILO (ILO, 2002) defines informal firms as: Unregistered Sole proprietorships operated by individuals or

households Lacking reliable accounts.

The ILO approach has been influential in most empirical studies in Africa

PROBLEMS WITH DEFINITIONS AND DATA COLLECTION STRATEGIES

PROBLEMS WITH DEFINITIONS AND DATA COLLECTION

STRATEGIES

Studies lack focus, conflating household, worker and entreprise surveys

Lack of comparability of results (e.g. whether or not agriculture is included)

International comparisons made consequently difficult to perform

INFORMALITY AS A CONTINUUM

The most used criteria in defining the informal sector:The size of activity criterionThe registration criteriaThe access to bank credit criterionThe mobility of the workplace criteriaThe existence of honest financial statements criterionNon payment of tax or type ox tax paidSocial secirity coverage

Very little overlap between classified as informal according to different criteria (eg Arabsheibani and Carneiro, 2006)

Important limitations when considered alone in defining the IS in the African context

INFORMALITY AS A CONTINUUM

No single criterion (firm size, registration, tax compliance) enables a clear distinction between formal and informal firms.

Informality usually reflects a combination of characteristics.

Steel and Snodgrass (2008) : « ..There is a continuum of different degrees of formality (in terms of different characteristics such as nature of registration, payment of taxes, management structure, contractual arrangements with employees, market orientation, etc.”

A growing body of literature acknowledges the heterogeneity of the informal sector but most empirical studies of the informal sector continue to classify firms as either formal or informal. (ILO, 2002, Arabsheibani, and Carneiro ‘2006, Guha-Khasnobis and Kanbur (2006)

We have tried to empirically implement the definition of the informal sector as a continuum.

INFORMALITY AS A CONTINUUM

Some similar results with mainstram literature’sMost of informal firms are small even though we

have big actors in AfricaMost are not registered with tax authority although

few are found with no registration with other government services

Productivity is lowerLower level of education and higher female presenceState failures and weak business climate are major

determinants of informality

INFORMALITY AS A CONTINUUM

INFORMALITY AND PRODUCTIVITY GAP

02.0e+07

4.0e+07

6.0e+07

productivite

0 1 2 3 4 5

02.0e+07

4.0e+07

6.0e+07

productivite

0 1 2 3 4 5

THE INFORMAL SECTOR AND EARNINGS IN WEST AFRICA

THE INCENTIVES TO RESPECT RULES AND OBLIGATIONS

Informality is viewed as choice based on the costs and benefits of formal versus informal status.

Cost of informality depends in part on the costs of sanctions for non-compliance and hence on the effectiveness of the legal system (Kanbur 2009, Gelb et al. 2009, Dabla-Norris et al. (2008)

Benefits of formalization depend on the quality of the business environment Verick (2006) Gatti and Honorati (2008)

Loayza (1996) the magnitude of the tax pressures, labor market restrictions (controlling for GDP per capita).

Friedman et al. (2000) corruption and bureaucracy

Azuma et Grossman (2002) the predatory state which splits the spoils between the ruling elite.

Perry et al. (2007) perceptions of the honesty and competence of public officials.

World Bank (2009) a malfunctioning state undermines “tax morale”.

STATE FAILURES UNDERLY THE COST/BENEFIT CHOICE

FACING FIRMS

- Main characteristics: level of turnover beyond thresholds qualifying for

presumptive tax, Informal organizational setting in most respects Accounting based on fake High firm mortality rate Name of the firm coincides with that of the owner Despite large size, firms remain individually or family-

controlled One single individual (usually a man) has total control

over all firm’s functions

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LARGE INFORMAL BUSINESSES IN WEST

AFRICA

LARGE INFORMAL BUSINESSES IN WEST AFRICA

Manifestly fraudulent accounts. Managers usually uneducated, even illiterate.

- How are they identified?From our interviewsFrom our surveysConfronting customs and tax services

statistics

LARGE INFORMAL BUSINESSES IN WEST AFRICA

Share in total country sample

Average sales(millions CFA

francs)

Average Number of Employees (including temporary workers)

FORMAL

Dakar 24% 833 9.6

Ouagadougou 13% 615 21.2

Cotonou 23% 725 22.1

LARGE INFORMAL

Dakar 16% 117 4.5

Ouagadougou 11% 155 6.1

Cotonou 15% 319 22.6

SMALL INFORMAL

Dakar 60% 13 4.2

Ouagadougou 76% 11 5.4

Cotonou 62% 13 5.8

Some Descriptive Statistics for the Three Levels of Informality in the Three Countries

PROPORTION OF FIRMS FOR WHICH IMPORTS ARE LARGER OR LESSER

THAN SALES, BY INDUSTRY

21Source: Benjamin et Mbaye (2009)

In Africa, ethnic and religious networks often provide a shadow institutional framework substituting for the state, linking informal operators.

Networks provide credit, market information, dispute resolution, safety net.

Networks are powerful and are both cause and effect of weakness of official institutional mechanisms.

Sometimes cross-border in nature.

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BUSINESS NETWORKS

Mourides are an Islamic brotherhood that emerged in the 19th century.

Specialized in groundnuts then migrated to cities where they became traders and accumulated capital.

Evolved into a sophisticated global informal trading network centered in informal markets of Dakar (Sandaga) and Touba linking traders in Africa, Europe, the United States and Asia.

Operate outside the control of the state. Touba and Sandaga off limits to the authorities.

Operates through strong bonds of solidarity, shared work ethic, and tacit contract enforcement.

Instantaneous transfer of credit around the world by telephone.23

BUSINESS NETWORKS: The Example of Mourides of Senegal

Large volume of unrecorded cross-border exchange in Africa (Golub and Mbaye 2009).

Causes of Smuggling: Porous borders between countries Large differences in import barriers, price controls,

subsidies etc. Ethnic and religious connections that transcend

borders (e.g. Mourides). Weak enforcement and corruption of customs

administration and other state agencies.24

CROSS-BORDER INFORMAL TRADE

Trade is carried out by a complex supply chain involving formal and informal firms.

Goods often imported by large official export-import firms who sell to large informal traders who in turn sell to smaller traders.

Large informal firms have government connections or are in the government (e.g. in Nigeria).

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FORMAL AND INFORMAL ACTORS IN CROSS-BORDER

TRADE

Benin to Nigeria: “Re-export” of imported used cars Nigeria to Benin: Smuggling of petroleum products Gambia to Senegal: Re-export of imported sugar

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SOME EXAMPLES OF INFORMAL CROSS-BORDER TRADE

IMPORT TAXES AND WHOLESALE PRICE DIFFERENCES

SENEGAL AND THE GAMBIA (%)

Import Taxes WholesalePrice DifferenceGambia Senegal Difference Senegal - The Gambia

Bulk ItemsSugar 22.5 103.8 81.3 90.5Flour 22.5 56.6 34.1 33.2Rice 16.8 22.7 5.9 13.1

Other Consumer GoodsCigarettes 58.0 97.7 39.7 29.4Cooking oil 22.5 56.6 34.1 57.9Tomato paste 28.3 56.6 28.3 62.6Tea 28.3 37.3 9.0 23.1Candles 39.8 44.8 5.0 70.4Canned sardines (carton)39.8 44.8 5.0 19.1Matches 39.8 44.8 5.0 70.5Mayonnaise 39.8 44.8 5.0 56.1Toilet soap 39.8 44.8 5.0 24.9Milk powder 22.5 27.1 4.6 39.5

IMPORTS PER CAPITA, CARS (MIRROR ROW EXPORTS TO, US DOLLARS)

Benin-Togo-Nigeria The Gambia-Senegal

IMPORTS PER CAPITA, SUGAR(MIRROR ROW EXPORTS TO, US DOLLARS)

Benin-Togo-Nigeria The Gambia-Senegal

Conclusions The World Bank (2009) Latin American study

emphasizes that the informal sector must be viewed as a systemic problem of state failure. This is even more true in Africa than in Latin America.

Despite this, there is insufficient information about the nature of the informal sector in Africa.

Informality should be viewed as a continuum. In Africa, the informal sector is the rule rather than the

exception. In Africa, the informal sector is not dominated by

independent microentreprises. It includes large players and organized networks.

In Africa, the informal sector transcends national borders.

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Recommendations: Encouraging Transition of Larger and More Productive Firms to the Formal Sector

Induce larger and more productive firms to transition to formal status by altering the cost/benefit calculus in favor of informality.

Carrots: Improving the business climate, including infrastructure, the fairness of taxation, the quality of business services, the simplicity of regulation, lowering corruption etc.

Sticks: Sanctioning firms that escape their tax and regulatory obligations

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Recommendations: Assisting Weaker Firms

For smaller and less productive firms, full transition from informality is not feasible (Gelb et al 2009). These firms have an important role in employment creation.

Develop appropriate forms of taxation and regulation that do not undermine the viability of these firms.

Improve access to education, training and other business services to raise productivity.

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