How Global Capital Incentivises Informality

The distinction between the formal and informal sector is a concept that is sometimes difficult to differentiate due to the fluid nature of their interactions. The multiple definitions of the informal sector have often not been precise, especially whenever it is looked at in relation to the formal economy, and not as a distinct entity.  It is with this in mind that the authors of the research paper “Informal Sector Dynamics and its Role in the Capital Accumulation Process” interestingly point out that the central meaning and relevance of this phenomenon of informality as a sector or workforce become clear only when considered in the light of the global capital accumulation process.

A significant part of the informal sector in the contemporary world is essentially an outgrowth of the formal economy in more ways than one. The activities in the informal sector are directly linked to and often constitute an essential part of the processes of production, exchange and accumulation in the capitalist economy both at the national and, increasingly, at global levels. In certain cases, the sector consists of industries that originated from basic units of production that are cemented in simple manufacturing processes and have evolved into factory forms with informal production and labour processes. It is common knowledge that in today’s world, this sector is an essential part of the global commodity chains.

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(Source:http://www.queensu.ca)

What is at the core in the interaction and dynamics between the two sectors is a range of flexibilities that can be ascribed to the informal sector or processes. In the current production and distribution networks, there is an array of operations that can be observed. These informal processes are visibly notable in global commodity chains whereby important stages of production and supply are located in third world countries. Factors that are common in informal circles such as the lack of a regulatory environment, the flexibility or absence of labour contracts and the ability to stretch hours of operation at ease are adopted by formal firms when they subcontract informal firms to perform some of their production and distribution jobs. It is this flexibility and managing to keep transaction and labour costs to the minimum, which is at the core of the dynamics of small enterprises that allows them to survive and provides them the competitive edge. This advantage is made use of by large multinationals in their pursuit of global profits.

As per the document, another way in which formal firms create informality is through their restructuring processes. This is done in whereby the formal firm downsizes its labour force and thus forcing people into the informal sector as a means of survival and source of livelihood. There are two distinct processes in which informalisation of employment takes place in formal sector firms. One is to employ labour without any permanent wage or employment contract or provide any employment benefit. The other is to contract out operations that were earlier performed by employees of the firm to smaller or ‘specialised’ enterprises. A particular form of this is to contract out operations to labour contractors or suppliers, where even if particular employees are regularly working in the principal firm, they are not considered the employees of the principal firm and are therefore denied any rights, which they would have otherwise got. The suppliers of such workers are often informal sector enterprises.

It is vital for policy makers and parties that are involved in drafting strategy to have a clear understanding of the definition of the informality as a means to getting to its root causes in a way that will enhance their engagement processes with the sector. This will assist them in moving away from instances where they rely on traditional definitions of the sector that have since evolved and thus be more specific in their goals for it.

litualex@gmail.com

Informal Economy Analyst.

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Impact Investing in Informal Enterprises

Impact investments are investments made into companies, organizations and funds with the intention to generate social and environmental impact alongside a financial return. The Global Impact Investment Network (GIIN) states that this sort of investment provides capital to address the world’s pressing challenges in sectors such as microfinance, sustainable agriculture, renewable energy, conservation and affordable and accessible basic services such as housing, healthcare and education. The aspect of this form of investment that makes it stand out from other vehicles of investment is the fact that it is aimed at generating positive impact beyond financial return. In this sense, it is a viable solution to the sustainable growth and development of micro, small and medium sized enterprises. It is a tool that can be used to provide patient capital to entrepreneurs, more so if it is blended with grants.

(Source: http://www.blog.kpmgafrica.com)

A study that was conducted in West Africa by Dalberg found that impact investments are primarily made by private equity and venture capital funds, Development Finance Institutions (DFIs), Micro Finance Institutions (MFIs), foundations and institutional investors. “Impact investing in West Africa” noted that the needs of individual enterprises varied depending on factors such as their business model, size and maturity stage as well as human resource capacity. Beyond financing needs, many enterprises require business development services in a way that enables them to develop their ideas and create well managed, financially sustainable operations.

Some of the challenges that stand in the way of achieving the goal of developing sustainable business ventures in as far as engagement with impact investing is concerned include a lack of education, skills and difficulty in accessing information among the entrepreneurs that are required to turn their ideas into bankable projects. Also, the lack of awareness of the actual implications of engaging impact investors prevents many businesses from accepting this type of capital. This is due to the fact that owners of small and medium sized enterprises fear losing control of their businesses. Further, the study noted that the lack of incentives to convert from informal to formal business structures was a hindrance for impact investors in as far as engaging the informal sector in West Africa goes. The high costs that are linked to business formalization which include licences, taxes and other operating costs discourage most informal businesses from making the transition to formality.

The report put forward some ways in which the above challenges can be mitigated for an enhanced and more proactive engagement with impact investment. These include the need for a broader range of flexible products to address the gap for businesses with smaller financing needs. This is particularly necessary for new enterprises where the entrepreneurs’ funding needs are too small for traditional debt or equity financing. In this sense, they propose angel financing or royalty-based debt with manageable levels of interest as well as supporting business development services.

The other solution highlights the need for investors to adapt their investment practices to the local climate. By being more flexible in this manner, they will be in a better position to change their investment criteria, thus opening up their business to a large number of potentially profitable deals. This will also place local entrepreneurs in a position where they can access much needed capital to enhance their business ventures. This sort of engagement will support the growth of informal businesses to formal businesses and further assist them to transition into larger private equity and traditional commercial bank investments.

Last but not least is the proposal to build networks and awareness beyond impact investors to encompass business support organisations, relevant government bodies and development partners with the intention of increasing awareness of existing definitions of impact investing. Other goals of these networks should be to increase the awareness of the benefits of venture philanthropy among grant-making organizations, increase the understanding of equity investments among business owners and focus outreach efforts towards high net worth individuals and highly-educated Africans in the diaspora.

litualex@gmail.com

Informal Economy Analyst

 

The Cost Of Informality

In a quest to formalise informal businesses, there are certain factors that stand in the way of this goal. It is clear that a good number of informal enterprises operate the way they do due to the underlying socio-economic background in which they find themselves working. For example, most of these are formed in areas where poverty is prevalent. In a bid to make these businesses formalise and hence become viable and profitable entities, some of these factors need to be taken into consideration as they can be used as catalysts or incentives to formalisation.

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The International Labour Organization points out the fact that informality inhibits investment in bigger business ventures because they lack the necessary capacity and size to fully exploit economies of scale. One factor that drives this notion is their low levels of productivity due to poor access to skilled labour. However, this is not the case for larger formal enterprises for they are in a better financial position to access high-skilled labour and can hence fully exploit economies of scale which enhances their profitability.

The lack of secure property rights especially for micro and small enterprises deprives them access to credit and capital. This is a huge hindrance whenever they try to expand their business operations in the sense that their businesses do not possess the legal title deeds to the physical residences on which they conduct business. In this sense, their businesses cannot be used as collateral whenever they try to get loans from financial institutions. This mode of operation also makes it difficult for them to access legal and judicial systems to enforce contracts.  This aspect for example impedes them whenever they try to participate in the tendering processes of bigger companies or even government business.

Another obstacle for informal businesses is that most of them lack social protection. The fact that a vast majority of these are not registered units puts them in a situation where they are not recognised by governments under which they operate and hence fall outside of the official regulation network. This leaves them vulnerable to exploitation for they are not protected by social and labour legislation. Corrupt government officials often demand bribes to ensure that they remain in business, which is an unnecessary expense in the long run.

What comes out clearly is that some of the mitigation strategies that need to be embraced and implemented revolve around issues that deal with capacity development especially upskilling as this is a crucial requirement for boosting the productivity of informal businesses. Also, the development and harmonization of informal organisational structures should be done in a way that enables them to own the working spaces under which they operate, be it on a collective or individual basis.  More importantly, the improvement of conditions of employment in the sector in as far as occupational safety and health policies are concerned is another area that needs to be addressed. This includes looking into the promotion of labour rights, the extension of social protection to reach the most vulnerable and a favourable regulatory environment that discourages corruption.

In a bid to encourage formalisation, the above factors need to be strongly considered. The most viable way to tackle the problem and move forward would be to target top tier small and micro businesses in each of the sub sectors in the informal economy and engage these in a pilot programme. This  would then be used to precisely map out the challenges faced on the path to formalisation with the aim of developing and implementing tailormade strategies for the different business sizes in each sub sector.

litualex@gmail.com

Informal Economy Analyst.

 

 

Lessons from China’s Economic Policy

Over the years, China has managed to turn around its economy by instituting certain reforms which have seen the country’s economy grow exponentially during the last 60 years into a global economic powerhouse. Most of these were done by recalibrating how they interacted with the informal sector in their country. The reforms first took shape in the agriculture sector with the household responsibility system (HRS) replacing the people’s commune system. Under this system, individual households were instituted as the basic unit of farm operation, as opposed to a collective team of 20 to 30 households in the past. The HRS gave individual households autonomy over production and farmers were given incentives to increase output.

(Source: http://media.philstar.com/images/the-philippine-star/business )

A study carried out by the Lancaster University Management School indicates that Between 1978 and 1984, China’s average annual growth rate of agriculture was 7.7%, after the introduction of the household responsibility system. The significant improvement in agriculture helped the country to release labour from land to industry and service sectors. This labour reallocation process was necessary as China’s agriculture was characterised by an egalitarian system of distribution of cultivated land with more than 200 million rural households, each cultivating less than 0.55 hectares. With the improvement in productivity in the agricultural sector, there was no need for a large number of people to stay on land. Agricultural employment as a share of labour force fell from more than 70% in 1978 to 60% in 1990 and 35% in 2011. The release of such a large number of economically active population from land hugely helped China’s development of the labour-intensive, low-skilled manufacturing sector.

In addition to the introduction of the HRS, China successfully re-introduced marketization. In implementing agricultural reforms, China first tried a dual-track approach. Under this approach, farmers were required to deliver a portion of their output to the state and allowed to sell the rest of the output on the free-market. With the newly earned profits, farmers set up or pulled resources into town and village owned enterprises (TVEs). These are communal organizations managed by managers on a contractual basis.

Town and village owned enterprise operate outside of the Chinese government’s apparatus and were highly market-oriented. Even though they did not enjoy preferential government treatment, they were also not subject to widespread state regulation. The study further notes that between 1979 and 1991, TVEs grew at an average rate of 25.3% in comparison to that of state owned enterprises which grew at 8.4%. Though TVEs were not private firms, since they were often owned by local governments or local communes rather than solely by private owners, they cultivated an internal culture of competition in the Chinese economy which helped stimulate efficiency of the state‐owned enterprises. It is worthy to note that TVEs were the major export drivers of China’s impressive export growth. For example, in 1999, the value of TVE exports of US$94 billion accounted for 48% of China’s total exports. Much of these were labour‐intensive products involving simple production techniques.

Another aspect that accelerated China’s growth and economic success can be attributed to privatisation. The study notes that the ownership structure of private firms was not properly defined until 1988. Private firms only became an integral part of the Chinese economy in 1997 and had their legal status established in 1998. The rapid growth of the private sector began with the introduction of the policy whereby the government not only lowered entry barriers in most sectors, but also pursued a policy of “grasping the big, and letting go of the small”. This meant that State Owned Enterprises were to only be kept in “strategic sectors” whereas small and medium sized enterprises (SMEs) were either privatised or their ownership transferred from the central government to local governments.

Lastly, the study shows that China’s development in manufacturing has also benefited from inward foreign direct investment (FDI) whereby the early years of China’s history of inward FDI was particularly dominated by the Chinese diaspora. Chinese diaspora-invested firms cooperated with TVEs and other indigenous Chinese firms and introduced them to international markets as well as freed them from domestic market constraints. In this sense, the diaspora-invested firms also helped indigenous Chinese firms to exploit the country’s comparative advantage in cheap labour and to translate its comparative advantage into international competitiveness.

Kenya is a country whereby about 75% of the population rely on agriculture for employment and livelihood. Outside agriculture, a vast majority of its citizens are employed in the informal economy, accounting for 90% of the employment demographic. The route taken by China is one which the country can borrow a leaf from when looking towards ways in which it can transform and grow its economy through agriculture and manufacturing.

litualex@gmail.com

Informal Economy Analyst.

 

 

 

Informality In Sub-Saharan Saharan Africa

The latest Regional Economic Outlook: Sub-Saharan Africa is a survey conducted and released twice a year by the International Monetary Fund (IMF). The latest was made public in April 2017 and highlights the importance of the informal economy as being a key component of most economies in Sub-Saharan Africa, contributing between 25 and 65 percent of GDP and accounting for up to 90% of jobs outside agriculture. This includes household enterprises that are not formally registered.

(Source: https://www.imf.org/~/media/Websites)

Estimation of the size of the informal economy is done by looking at indicators such as the tax burden, institutional development and unemployment rates amongst other factors. According to the paper, a larger tax burden is likely to encourage more economic activity to remain in the informal economy. The level of institutional development is another indicator whereby the lack of respect for the law encourages informal activity. Higher unemployment rates are an indicator of poorly functioning labour markets with labour not being absorbed into the formal sector.

The IMF indicates that the average share of informality in Sub-Saharan Africa reached almost 38% of GDP during 2010 – 2014. This is surpassed only by Latin America and the Caribbean at 40% of GDP and compares with 34% of GDP in South Asia, and 23% of GDP in Europe. In member countries of the Organisation for Economic Cooperation and Development (OECD), the informal sector is estimated to account for 17% of GDP. Their findings suggest that informality seems to fall with the level of income, likely reflecting higher government capacity and better incentives towards formality in higher income economies.

In terms of the experience of its populations as entrepreneurs, Sub-Saharan Africa has the highest rate of early stage entrepreneurial activity. However, about a third of the new entrepreneurs in the region report that they chose to be entrepreneurs out of necessity. Despite this, the region has the most positive attitude towards entrepreneurship. The policy change proposed in this regard is to create an environment in which small firms in both formal and informal sectors can thrive and grow, one that is supportive of SMEs.

As far as informality and productivity is concerned, high levels of informality in the informal sector have significant implications on productivity. This in turn negatively impacts economic performance. The paper draws certain conclusions from World Bank Enterprise Surveys which indicate that the productivity levels of informal firms are significantly lower than those of formal firms. On average, the productivity of informal firms is only 25% of small formal firms and 19% of medium sized formal firms, based on real output per employee. This reflects a lower level of physical capital and skill levels of informal workers.

In regard to tax policy, the document proposes that relatively high VAT thresholds are recommended for developing countries, with licences and fees for businesses below the VAT threshold. Such a move would reduce the number of small businesses that are discouraged from registering with the tax administration. As a result, the increased growth and transition into formality would allow small enterprises to grow to a size above the tax threshold, generating higher fiscal revenue. The benefit for formalisation would be better access to finance and public services, which would exceed the tax cost.

Moving forward, countries in the region need to focus on developing strategies that will not only foster and support the positive growth of informal sector activities, but also go further to incentivise their graduation into the formal sector. The importance of capacity building initiatives in the areas of technical, financial and management skills as well as those that are centred around technology adoption as a means to increasing their productivity cannot be overlooked if this is to achieved.

litualex@gmail.com

Informal Economy Analyst.

 

 

Leveraging Informal Business

Considering the fact that sustained poverty coupled with subpar economic growth has continued to inhibit growth in the demand of locally manufactured goods, effective demand continues to shift more in favour of relatively cheaper imported manufactured items. In addition, the high cost of inputs informed by poor infrastructure which leads to high transport costs has led to high prices of locally manufactured products thereby limiting their competitiveness in the local and regional markets. With the view of looking towards ways in which this trend can be turned around to benefit locally manufactured products, certain aspects need to be taken into consideration.

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Working through the informal sector is one of the avenues that presents a huge opportunity when it comes to penetrating the local and regional markets. The sector has market networks that are vastly untapped. Formal firms need to venture further into fostering links with informal firms in a way that is mutually beneficial. In this sense, there are different ways in which this can be achieved.

The first and foremost aspect that formal firms should look into in order to get the right partners to work with in the informal sector is that of the business structure that is present in the informal business that they intend to partner with. The importance of ensuring that they establish this aspect is, among other factors to assist them in better understanding the client profiles of the clients serviced by informal firms.  Informal businesses have an access to clients that would not be readily available to formal businesses. Customers to their businesses often purchase goods and services that are at a lower price point. Tapping into the economies of scale from this angle will be a huge plus for any formal business that can avail their products and services that meet the needs of these customers. Unpacking this dynamic will assist in coming up with tailor made marketing structures around which they can upscale the production of their products and services.

Another thing to consider that is of importance in as far as fostering beneficial relationships relates to the different levels of  capacity present in the informal firms. These include, but are not limited to technical and financial skills. Most informal firms primarily under perform due the low levels of the above mentioned. Formal firms can work to improve the level of these skill sets which will go a long way in improving the quality of goods and services that they produce. Mentoring informal firms in this way will enhance their capability to deliver goods and services that are of a higher quality as well as enhance their systems of operation. This will further improve and strengthen the various aspects that are related to the operational systems of formal firms such as their chains of distribution.

An area that would be worth exploring for formal firms as they seek to establish formidable links with informal businesses is that of targeting businesses that are part of an association, be they in the form of Sacco’s or cooperatives.  Micro, small and medium sized businesses that are members of associations within their realms of operation tend to be more focused and better organized. This is due to the fact that they draw valuable lessons from each other on best industry practices. These sorts of associations provide a unity of purpose and act as a pillar of stability for informal businesses for it is through them that they can better interact with other bodies such as government bodies in cases of conflict resolution or even financial institutions whenever they require to access loans. Associations in this sense, offer security to the individual entrepreneurs, for it is through these that they can access loans to grow their businesses as well as better market their products.

Businesses in the manufacturing sector should look into value addition strategies that target the micro and small businesses that they intend to be suppliers of raw materials for their finished products. This is especially important for those that rely on agricultural raw materials. Partnering with small scale farmers for example, with a view of improving the quality of their yields, is a worthwhile investment. Promoting a culture of interacting with these farmers on best practices in crop and animal husbandry is a long-term investment that will ensure a long term consistent availability of good quality raw materials, as well as improve the incomes on both sides of the coin.

By looking into the above factors, formal firms can have a better understanding of informal businesses when trying to create partnership opportunities that grow their businesses. Working with the associations that informal businesses are a part of will enhance the capability of formal firms to choose credible businesses through which they can further harness their growth agenda as well as build the capacity of informal businesses.

litualex@gmail.com

Informal Economy Analyst

Supporting Economic Transformation through Informal Economy

 

Last week, the Kenya Association of Manufactures (KAM) in association with the Overseas Development Institute’s (ODI) programme, Supporting Economic Transformation (SET) launched the Ten Policy Priorities for Transforming Manufacturing and Creating Jobs in Kenya. The document is a ten-point policy plan aimed at creating 300,000 jobs and doubling manufacturing in five years. According to the document, this will be achieved through two main ways;

(Source: http://www.kam.co.ke/KAM-2016/wp-content/uploads)

  1. The formulation of effective public policies and the regulation for manufacturing competitiveness by doing the following;
  • Creating a business environment that is conducive to manufacturing investment.
  • Enforcing a fiscal regime that supports manufacturing.
  • Making land ownership more affordable and accessible.
  • Securing affordable, reliable and sustainable energy.
  • Expanding access to long-term finance for all types of manufacturing firms.
  • Creating an exports push for manufactured products.
  • Developing worker skills as well as supporting innovation for increased labour productivity.

 

  1. Efficient and effective implementation through;
  • Creating a fit-for-purpose public service.
  • Developing a coordinated value chain approach.
  • Building trust and reciprocity for effective coordination and partnerships.

There is a proposed plan to inclusively target Informal industry or cottage industries. According to the document, there are several manufacturing sub-sectors such as agro-processing, metal works, furniture, and leather and shoe making. Following earlier research that has been carried out on the informal manufacturing sector in Kenya by Deloitte and The World Bank, four sub sectors have been singled out as having the greatest potential for growth and performance. The first is the arts and crafts which consists of homemade artefacts that are a popular product for tourists and residents.

The other strong informal manufacturing sub sector is that of furniture. The furniture market in Kenya stood at approximately $496 million in sales in 2013, whereby East African economies purchase $1.2 billion worth of furniture annually. Jua kali represent more than a third of sales in Kenya ($160 million). The jua kali furniture industry exhibits strong growth and manufactures world class ethnic furniture for niche markets in areas such as Lamu.

The third is the metal works informal manufacturing sector which produces a range of products such as charcoal cooking stoves, buckets, pans, kitchen utensils, wheel barrows, watering cans, gates and grills, and small tools for low-income clients. Products such as industrial sculptures and artworks target higher-income clients. Additionally, a few informal manufacturers produce a limited number of spare parts such as silencers, auto upholstery, and rubber bushings.

The last one is the leather industry under which the informal sector accounts for 10,000 of the 14,000 workers. Kenya is the third-largest livestock holder in Africa, so leather represents a potential area for economic growth and employment. In 2017, the Ministry of Industry Trade and Cooperatives (MITC) committed a KSh 130 million revolving fund for SMEs in the leather industry to build workspaces in all of the country’s 47 counties.

The ten-point plan further points out that despite this potential, there are challenges that the informal sector faces which include access to finance, limited access to land, corruption and labour productivity. With the successful implementation of this document, the informal manufacturing sector stands to immensely benefit from the catalysis of manufacturing in Kenya.

litualex@gmail.com

Informal Economy Analyst