Tapping into the informal economy

Experience gathered while working as a salesperson shed light on the mode of operation of businesses that are classified as informal. Interactions with these entities were often riddled with out of the norm characteristics, an aspect that was key to their survival. Due to the fact that the ability to sustain businesses of such a nature is highly dependent on a mode of operation that infringes on the principles of formal business, it did not come as a surprise when I was exposed to business practices that would be otherwise not fall under the scope of formal business operation, but which were a determination of how well they performed.

(Image source: https://coinpedia.org)

A common mode of operation that I was exposed to revolved around distribution businesses which only had one registered business for the purpose of legal conformity but had at least five other branches that operated informally, in that they were outlets that were drop off and collection points for their clients. In these predominantly rural markets, the subsidiary outlets were preferred due to the discounted rates that they offered that were mainly enabled by the volume of products that they pushed out into their wide market reach.

Ideally, the amount of revenue that could be collected from these by the respective county governments vis a vis the payments that they make to the county authorities pale in comparison. Which begs the question, why do businesses that generate so much revenue choose to remain under the radar in this sense? Beyond sealing such loopholes that rob county governments of crucial revenue, it is of the essence for a business environment to exist whereby levies and taxes charged match service delivery by governments to businesses.

When referring to service delivery, key issues that constantly came up included the physical business environment revolving around matters that deal with sanitation and security, repetitional levies charged across different counties as well as market infrastructure challenges such as proper road networks that enhance market access. These are crucial to building links with an informal sector that is highly undervalued and under rated, considering that as per statistics from the Kenyan Economic Survey 2018 released by the Kenya National Bureau of Statistics (KNBS), the sector accounts for 83% of employed Kenyans.

There are key systemic issues that need to be addressed, as they are in the most part responsible for businesses being considered too risky for financial institutions, while at the same time being a reason as to why they thrive. The lack of a financial track record hugely facilitates their being off the radar of government authorities. Also, the issue of collateral is a stumbling block for small businesses that are run by women, due to a discriminant property rights and inheritance system.

In a bid to improve livelihoods and reduce poverty rates in the country, tapping into the positive aspects of the ecosystem that is the informal sector will go a long way in achieving this goal. Issues that deal with business practices that enhance their viability for access to finance such as proper bookkeeping, ancient legal rights as well as the availability and access to health insurance options are vital for strategic growth of the sector.

litualex@gmail.com

Informal Economy Analyst.

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Addressing Informality

The report “Women and Men in the Informal Economy” by the International Labour Organization (ILO) states that informal employment is the main source of employment in Africa, accounting for 85.8 percent of all employment, or 71.9 percent, excluding agriculture. Further, their research points out that 92.4 percent of all economic units in Africa are informal. An even more staggering statistic from the report is that 97.9 percent of the agricultural sector on the continent is informal.

(Image source: https://www.redpepper.org.uk)

The growth in the size of the informal economy should send a signal to policy makers that therein lies an untapped opportunity in as far as reaping mutual economic benefits. By this, I mean that due to the fact that in Kenya this sector of the economy contributes about 83% of employment demographic outside agriculture and yet only accounts for about 30% of the country’s GDP. This indicates that there is a gap that could be exploited. Some of the factors that inform this scenario revolve around issues such as the low levels of productivity as well as profitability in the sector. On the other hand, there has been an increased push to try and unlock issues that the sector grapples with such as access to finance, which has been a key factor that inhibits them from scaling their operations.

In an effort to make informal businesses profitable entities that can increasingly feed into formal business value chains as well as reduce their high-risk profile to financial institutions that they approach for credit, there are a couple of points that need to be taken into mind. The first and foremost is that of ensuring that small businesses develop the internal structures that can be used to measure their operations. These include proper financial records through book keeping which involves maintaining well structured and up to date records of accounts and financial transactions. This will enable them to not only be in a better position when applying for credit, but also ensure that they absorb these funds for purposes that will help them to scale up.

On the issue of productivity, beyond access to finance are factors such as the level of skills and access to markets. In most cases, businesses in the sector are set up not as a first option but as a last resort and a means of survival. A good example is that of businesses that are set by people who cannot access the shrinking formal employment opportunities and thus pursue the option of setting up a business in an attempt to cater for their expenses. Such entrepreneurs usually do not posses the skills required to venture into the various business fields that they find themselves in. It is not surprising that most of these entities close shop within two to three years of operation.

Access to markets is a hindrance to the productivity of some informal businesses in the sense that it limits the output of their goods in instances where ready markets are not available. In the case of small scale farmers, a lack of markets for their produce makes them scale back on their production due to their inability to absorb the shock that comes from losses from wasted produce. Most opt to take the route of subsistence farming. Linked to this is the fact that most have to grapple with inadequate storage facilities that could mitigate such losses.

It is therefore prudent and timely for policy makers to implement a strategy that addresses the issue of informality as a priority. This will not only enable governments to comfortably widen their revenue source while, but also improve the livelihoods of people who are struggling to make a living.

litualex@gmail.com

Informal Economy Analyst.

Lessons from China  – Informal Sector Transformation

Different studies have been conducted to unpack the genesis of how China’s economy grew from an average of 5.3% GDP between 1960 and 1978, to an average of 10.4% in 2010. There are valuable lessons to be learnt from these studies and to which parallels can be drawn for countries with vibrant informal economies looking to spur economic growth. One such study that was conducted by Professor Franklin Allen of Wharton University indicated that in as much as China’s consistent economic growth over the past five decades has been spearheaded by state owned and publicly traded companies, the informal sector contributed immensely to this drive. While the former grew at an annual rate of 4% from 1995 to 1999, the latter grew at 19%.

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It further noted that rather than turn to banks for financing, entrepreneurs tended to raise capital through local community networks and investors from abroad through informal borrowing from firms and institutions. Linking this to the Kenyan scenario, I believe that the key to the success of such a path heavily lies with the strengthening of informal sector organisations such as Savings and Credit Cooperative Organizations (SACCOs) as these are the bodies that are used by players in the sector.

The Chinese government has facilitated the growth of informal businesses from small business units to a level where they have become profitable entities that have been the backbone of the country’s industrialization agenda. Another study by the Lancaster University Management School points to the fact that the introduction of a household responsibility system (HRS) in China gave individual households autonomy over agricultural production and were incentivised to increase output. The resultant improvement in agricultural productivity enhanced the release of excess labour from the agriculture sector and reallocated it to the industry and services sectors. This policy saw the share of agricultural employment fall from 70% in 1979 to 35% in 2011.

With farmers being more profitable, the extra disposable income was pulled and invested in town and village owned enterprises (TVEs), which were largely informal. It is interesting to note that although TVEs did not get preferential government treatment, they were not subject to widespread state regulation, an aspect that enabled them to grow faster than state owned organizations. Though TVEs were not private firms in the sense that they were owned by local communities rather than sole private owners, they cultivated a culture of competition which helped stimulate the efficiency of state owned enterprises. It is worthy to note that they were the major export drivers whereby for example, in 1999 their export value accounted for 48% of China’s total exports.

These two studies clearly highlight the importance of how concerted efforts to increase the productivity of small scale businesses lead to a government and its citizens reaping the fruits of economic growth and prosperity. It is not surprising that given such reforms, the World Bank indicates that the current poverty rate in China is under 2%, down from 90% in 1981 having managed to lift 800 million people out of the bracket. Clearly, they are doing something right which we can emulate.

litualex@gmail.com

Informal Economy Analyst.

The relationship between poverty and the informal economy

The number of people who are engaged in informal employment has been on a steady rise over the past decade, a phenomenon that is increasingly prevalent in developing and third world countries. A deeper delve into this issue reveals an intricate relationship between the level of informality in various regions of the world and the link to social inequality. That being said, it is interesting to note that regions with large informal economies also have a big percentage of the population living in poverty. This is not to say that all of those that are engaged in informal businesses are poor, but that poverty is a cardinal driver that accentuates informality.

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Given the diminishing opportunities of formal employment opportunities in these parts of the world, populations have been forced to look for alternative creative means to fend for themselves. This scenario has largely led to the growth of informality whereby businesses are haphazardly set up without prior planning or experience. Often, the jobs in this sector of an economy are of poor quality, meaning that they do not offer any social protection or terminal benefits. Business that are established this way often have internal operational systems that are a hindrance to their growth in the long-term. It is this sort of enterprises that have difficulty accessing potential financial investors due to the perceived high-risk nature of their operations.

The World Employment and Social Outlook 2018 is a report by the International Labour Organization (ILO) that focuses on the trends in job quality, paying particular attention to working poverty and vulnerable employment. A point that comes out strongly is the fact that in 2018 and 2019, unemployment in developing countries is expected to rise by half a million people per year. As alluded to earlier, the report points out the fact that the main challenges that developing countries continue to face include persistent poor-quality employment and working poverty. Two demographic groups that continue to be adversely affected by labour market inequalities are women and the youth.

According to the report, the outlook is particularly challenging for women as they are more likely to be in vulnerable employment and over-represented in informal non-agricultural employment. Further, this demographic group is often less eligible for social protection coverage due to their lower rates of labour force participation, higher levels of unemployment and greater likelihood of being in vulnerable forms of employment. These factors, coupled with the fact that women usually receive lower levels of remuneration, raise their risk of poverty. An interesting statistic that came across concerning youth aged 25 years and under is that their global unemployment rate of 13 percent is three times higher than the adult unemployment rate. The Northern Africa region recorded the highest rate with close to 30 percent of young people in the labour market being jobless.

Such numbers are a strong indicator as to why the informal economy continues to consistently grow. The downside to having a large informal economy is that those that are involved in micro businesses are excluded from the benefits that come with gainful employment. It would be prudent for policy and decision makers to look into and implement strategies that grow the capacity of informal businesses to enable them to become profitable entities. This will reduce the high levels of poverty by providing sustainable incomes to a vast majority of households.

litualex@gmail.com

Informal Economy Analyst

Value Chain Development in the Informal Sector

A value chain is defined as the full range of activities that are required to bring a product or service from conception, through the intermediary phases of production and eventual delivery to final consumers. Value chains can be local, national or global, linking rural producers with traders and consumers worldwide. Their role in determining the quality and cost of a product and service cannot be overlooked for it is through them that effective competitiveness can be achieved.

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It is hence important to understand the role value chains play in the route to market trajectory of any service or product. Thus, a value chain analysis at both firm and sector level is key to developing strategies aimed at improving the competitiveness of a product or service. At the firm level, this sort of analysis would be important for formal businesses to understand how much informality is in their value chain, as this will help them pin point areas through which they can fine tune the process in a bid to achieve quality standards in a cost-effective manner. At a sectoral level, it would provide information as to where informality sits in each sector and thus give a better understanding of which sectors have the densest or least levels of informality in their value chains, with the view to increasing their overall efficiency and competitiveness.

Considering that sustained poverty coupled with subpar economic growth has continued to inhibit the growth in the demand of locally manufactured goods, relatively cheaper internationally manufactured goods continue to gain the local market share. In this sense, locally manufactured goods are limited in their competitiveness. For example, value addition strategies that target micro and small businesses would greatly improve the quality of locally produced goods. In its strategy on decent work in the informal economy, the International Labor Organization (ILO) proposes that one way of improving the sustainability of informal enterprises may be to link them in cooperatives where jointly owned input supply, credit and marketing services can be organised without compromising the autonomy of the individual entrepreneur.

In markets that are dominated by very powerful players, small producers tend to be highly disadvantaged by being arm twisted into accepting lower income for their produce. A good example is in the agricultural sector where small-scale farmers have little control of market dynamics, hence cannot reap the full financial benefits due to issues such as the lack of proper storage facilities, market information and access to inputs. This leads to post-harvest wastage and losses brought about by hurriedly selling their produce at lower prices than if they had stored it for sale when demand is higher. It is with such issues in mind that the ILO stresses the importance of the improvement of value chain competitiveness, as it is seen as a powerful approach for generating growth and reducing poverty in developing countries, where roughly 75 percent of the population live in rural areas.

In a quest to integrate micro and small-scale enterprises into formal value chains, understanding their level of involvement in these is key to formulating policies and implementing strategies that contribute to the overall efficiency and competitiveness of locally manufactured products. This sort of analysis will benefit all the players along the value chain.

litualex@gmail.com

Informal Economy Analyst

The link between counterfeiting and the Informal Economy

Trade in counterfeit products is a thriving business in areas with large informal economies for consumers are presented with products at substantially lower price points than the original products. The issue of aspirational satisfaction is another major reason why a good number of clients in informal economies opt to purchase counterfeit and pirated products. Also, most of the customers of these products in informal economies are usually faced with substantial budgetary constraints. Interestingly, the hazards that are associated with such products rarely feature on the minds of these customers. While looking at the issue of counterfeiting and piracy, clients that purchase these products either do so knowing that the products are counterfeit or are oblivious to the fact that the products are fake.

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It is important to note that counterfeiting and piracy steals market share from legitimate businesses and undermine innovation, which usually negatively affects economic growth. Criminal networks and organised crime thrive via counterfeiting and piracy activities. It is not surprising that such groups target informal markets as a means to distribute their products, given that these offer them higher profit margins. Also, given the unregulated structure of such markets, they encounter a lower risk of detection. Another factor that makes these markets attractive is their large nature, which offers manufacturers of counterfeit products a huge market in which they can trade, given the intricate distribution networks that exist therein.

A report by the Organization for Economic Cooperation and Development (OECD) that delves into the economic impact of counterfeits and piracy raises some of the key concerns in terms of the effects that these products have and classifies these into different categories. I would like to concentrate on some of the socioeconomic effects, with a specific focus on criminal activities and employment.

In as far as criminal activities are concerned, the report makes the point that counterfeiting and piracy transfer economic rents to parties which are often engaged in a variety of illegal activities, including tax evasion and drug trafficking. It can be assumed that a portion of the rents is eventually used to sustain further criminal activity, in a corrupt and organised manner. While I tend to agree with this point of view, it is important to add that informal markets have for long been driven by a sense of micro entrepreneurship that has birthed innovative ideas and products due to the cut-throat environment under which they operate, with the view of trying to remain afloat. Seeing as most businesses in the sector operate in areas that are intricately intertwined with poverty, the quest to make a quick buck will push most of them to disregard intellectual property rights and opt to sell products that are in demand.

Counterfeiting and piracy affect employment by shifting jobs from rights holders to infringing parties, which is where a large part of the informal economy comes into play. The shift has implications for the welfare of employees as working conditions in the sectors where these activities occur are often far poorer than those prevailing in the recognised firms that usually offer their employees better terms of employment and adhere to health and safety standards. Although OECD raises a fair point in this sense, it is of vital to take into consideration the fact that unemployment is a scourge that is bedevilling developing nations. The shrinking availability of formal employment opportunities leaves even highly qualified graduates with little option but to venture into informal business that are a huge driver for pirated products due to their higher unit profitability.

While trying to unpack the issues that arise from counterfeiting and piracy, it is crucial to unpack these by looking at both sides of the equation. Understanding the drivers of counterfeiting from an informal sector perspective is key to finding viable solutions to this vice. For example, companies that manufacture cosmetic products can produce smaller package units that are targeted at informal markets. This would enable them to tap into the consumer demographic in such economies. This strategy has been successfully implemented by some multinational companies that manufacture household consumables. Seeing informal markets as part of the solution instead of the problem will immensely contribute to the strategy aimed at combating counterfeiting and piracy.

litualex@gmail.com

Informal Economy Analyst.

The Politics of the Informal Economy

The informal economy has gradually been growing in size over the past few decades. The sector is a significant part of economies in developing nations, especially those in Latin America and Sub-Saharan Africa. In some parts of these regions, it accounts for up to 90% of the employment demographic and contributes up to 40% of GDP in others. While these statistics may look appealing at face value, a deeper understanding of the dynamics within the sector present a different picture.

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At face value, the statistics on employment can easily be misconstrued as a representation of positive social development. In reality, a majority of those that are engaged in informal businesses venture into it due to the lack of options to earn a living. A commonality in the regions where the sector is a prevalent feature of national socio-economic parameters, issues such as a shrinking availability of formal employment opportunities as well as the high levels of poverty and inequality are prevalent.

Some factors that keep those that are engaged in the sector trapped in informality include poor access to finance that would facilitate the scaling of their businesses, the application of low level skills without upgrading these over time which affects their productivity and the lack of properly structured business records. A big percentage of business owners in the sector remain caged in poverty cycles which inhibit their graduation into prosperity. In this ecosystem, the status quo upholds a scenario whereby cheap raw materials and human resource are available for established formal enterprise.

It is interesting to note that myths about the informal economy are based on issues such as governance and taxation. One such misconception is that informal businesses are plagued by a lack of regulation. Most informal businesses operate through institutions whose basis of operation revolves around interest groups around which they tend to organise. In a policy brief paper, the Netherlands Institute of International Relations clarifies this by pointing out that the informal economy can be understood as an alternative mode of economic governance outside the state. The term “hybrid governance” is used to provide a more accurate depiction of actual economic governance in the sector, whereby the state has no exclusive regulatory authority over economic activities and non-state institutional arrangements provide a form of economic order.

Also, the myth about taxation of informal enterprises is that they do not pay taxes. The institute further acknowledges that cases of informal taxation of small traders exist whereby they pay a ‘special fee’ in return for a lower tax or protection from harassment by state agents such as customs officials or police officers. In Kenya, this scenario presents itself in cases where small traders pay cess fees to county governments under which they operate.

All in all, the informal sector is one that is seldom understood and often misrepresented. This can be attributed to its neglect by the governments under which it operates, mainly due to the fact that a majority of those that are engaged in the sector mostly consist of the financially disempowered members of the society. It is imperative that the interventions aimed at supporting this crucial sector of the economy are streamlined into public policy. Implementation of such strategy will provide a solid foundation upon which sustainable economic empowerment and financial inclusion can be achieved.

litualex@gmail.com

Informal Economy Analyst