Formalising the Informal Sector

The informal sector consists of businesses whose operation falls outside of official government parameters for a number of reasons. This puts these entities at a disadvantage as they are often excluded from the benefits that come with formalisation. In this sense, they do not have access to vital support systems that cushion them from the shocks encountered while running a business. Efforts geared towards tackling informality have often been focused on looking for ways through which these businesses can be formalised. There are issues that have to be considered for this to be effectively achieved. Peruvian economist Hernando de Soto is of the view that many people join the informal economy because the red tape alongside the bribes that go with it, virtually make it impossible for them to operate legally.

(Source: https://nephist.files.wordpress.com)

One disadvantage of having a large informal sector is that it deprives governments of crucial revenue for most businesses in this portion of the economy do not pay taxes. Anzetse Were, a Kenyan development economist, is of the view that there are a couple of barriers that hinder the transition into formality which fall into two categories. The first is the expense of transition whereby business registration and licencing processes are laborious processes. The other is the fact that formality is linked to expensive compliance requirements such as complying to inspection standards, paying high wages and taxation. A clear case has yet to be made to informal businesses to convince them of the benefits they would accrue from formalising and entering the tax net.

In the quest to formalise informal businesses, there are factors that should be taken into consideration as well as a process that can be followed that will ensure sustainable business entities are developed. Some of the systems that need to be put in place revolve around strengthening operational capacity, productivity and profitability, legal support and lastly financing and mentoring.

In as far as strengthening the operational capacity of informal businesses goes, interventions should focus on training that is aimed at streamlining internal operations such as maintaining and updating business records, upgrading of skills and developing strategic business plans that demonstrate clear expansion strategies. Proper business records place these businesses in a better negotiation space when approaching financial institutions for collateral to expand their operations. Skills upgrading will enable informal enterprises to enhance the quality of their products and services by ensuring that products are uniform and standardised while the services are up to date and conform to industry expectations.

Working on improving the productivity and profitability component entails looking at factors such as access to skilled labour as well as a focus on marketing. Informal enterprises find it hard to attract and maintain high skilled labour due to their financial position, which negatively impacts their productivity. This is not the case for larger formal enterprises for they are better financially placed to attract this resource and can hence fully exploit economies of scale, thus enhancing their profitability.

The issues around legal support involve matters to do with conformity to labour laws and taxation rules in accordance with the law. Informal businesses need professional support when configuring their internal operational systems. They require guidance in this area so as to ensure that they fully understand labour law and taxation requirements. This will equip them with the information they need when interacting with the authorities that implement these laws, thus reducing incidences where they are extorted due to ignorance.

Last but not least is the component of financing and mentoring. Most informal businesses find it challenging to access funds to upscale their operations. Most financial institutions turn them away due to their high-risk nature. The most suitable approach to be used when thinking of financing these businesses should consider offering affordable and patient finance models. This can be in the form of interest free loans, concessional loans and grants. It is key to couple such interventions with mentoring programs with formal businesses in a process that equips the informal enterprises with the necessary experience and expertise.

It is vital to ensure that the aforementioned basic components are taken into consideration by policy makers when they consider employing interventions that are aimed at supporting informal businesses in a way that enables them to formalise. There is much more that can be done to ease this process which includes offering incentives to encourage formalisation such as offering introductory or subsidised tax rates for newly registered businesses. These will however need to be thoroughly thought through to minimise loopholes that can be taken advantage of by scrupulous businesses.

litualex@gmail.com

Informal Economy Analyst  

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Comparative Analysis of Informal Economy in Nigeria and Kenya

The Informal Sector in Nigeria and its Impact on Development is a book by Stephanie Itimi which is based on research on the informal sector in Nigeria. It focuses on three key areas namely employment, gender equality and tax evasion. Employment is looked at from the angle of the effect that the informal sector has on job creation. Gender equality merges with employment and is looked into by examining the role that the latter plays in empowering women financially. The author also provides an analysis of the complex relationship between the informal sector and the principle of tax evasion. This article aims at providing a comparative analysis of the informal sector in Nigeria and Kenya, based on the findings of the book, as well as those from research conducted on the Kenyan informal sector.

(Source: https://images-eu.ssl-images-amazon.com)

In Nigeria, the informal sector accounts an estimate of 70% of the total industrial employment. The country has the largest informal sector on the continent, which is enhanced by its population size as well as high levels of poverty. The Federal Office of Statistics (FOS) states that the informal sector creates 25,000 to 35,000 jobs each year. However, although this is highlights the job creation role of the informal sector, the author argues that with a country of 153.9 million people, the impact of the informal sector on unemployment is quite insignificant.

The Kenya Economic Survey 2017 indicates that the total number of new jobs created in the economy was 832.9 thousand. Of these, 85.6 thousand were in the formal sector while 747.3 thousand were created in the informal sector. The share of new jobs created in the informal economy represents a 5.9% growth from 83% recorded the previous year to 89.7%, or 13.3 million people. Nigeria outweighs Kenya’s working population by 66.33 million, however the significant gap is not reflected in the differences in the number of people in the informal sector between Nigeria and Kenya. This is due to Kenya having 89.7% of its working population in the informal sector, while Nigeria has only 34.6% of its working population in the informal sector.

In her book, Stephanie points out that the percentage of women in the informal sector of any economy is high, especially in developing and transition economies by referencing an ILO report which found that 46% of the informal sector in urban Nigeria was dominated by women. She states that the informal sector is seen as a major source of employment for women due to its suitability to their needs. The Micro Small and Medium Sized Enterprises Report 2016, released by the Kenya national Bureau of Statistics (KNBS), indicates that 32.2% of licenced establishments were owned by women, while 60.7% of unlicenced establishments were also owned by women. According to Bitange Ndemo, an associate professor at the University of Nairobi, these statistics mirror a global trend whereby women are over represented in the informal economy; a factor that is largely driven by survival, rather than the exploitation of an entrepreneurial opportunity. In terms of financing informal business, he argues that the problem faced is more of the cost of finance rather than it’s access.

On tax evasion as regards informality in Nigeria, the author notes that research has shown that there is a positive correlation between a rise in taxation and a rise in tax evasion, concluding it as a motivational factor for people migrating from the formal to the informal sector. However, factors such as an increase in tax evasion punishments such as heavy fines and prison sentences reduced the likelihood of people participating in the informal sector. Informal Sector and Taxation in Kenya is a publication by the Institute of Economic Affairs (IEA) that stresses the significance role that the informal sector can play in the quest to expand the tax base, noting that the intention of bringing the informal sector into the tax net is to facilitate the transition of these businesses to the formal sector and reduce barriers for all businesses. The paper shows that by extending the tax net to the informal sector, for example in the year 2008, the Kenyan government could have increased the tax base by approximately 7.66 percentage points, translating to revenue worth Kshs.79.3 billion.

In conclusion, as is the case in as far as data on the informal sector is concerned, the author indicates that one of the biggest impediments encountered during her research is its limitation which involved the omission of data in some years and unavailability of up to date research. To this end, she proposes that primary research should be conducted in to have a more up to date and realistic perspective on the topic. The part the informal sector plays in enhancing gender equality is restricted on just income, as female participants are able to easily obtain employment in the informal sector and adapt their job rule to their social and culture gender obligations. Also, government agencies should move from harsh approaches such as destroying informal market areas and increasing tax evasion punishments to more liberal approaches that empowers the activities of the informal sector through the provision of a conducive environment and inclusive policies which enhances productivity within the sector and enables taxation.

litualex@gmail.com

Informal Economy Analyst

 

 

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.

https://i2.wp.com/www.queensu.ca/innovationcentre/sites/webpublish.queensu.ca.qicwww/files/images/shutterstock_715692881_REV-950x405.jpg

(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.

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 African Retail Market

According to the United Nations Economic Commission for Africa (UNECA), the African retail market is characterised by approximately 90% of transactions occurring through informal channels. This points to the existence of an opportunity for the increased establishment of formal retail presence to capture larger portions of this market share. Tapping into markets that are dominated by the informal economy presents formal retailers with a key to unlocking the potential of the African market in as far as leveraging the customer base presented by the population therein. However, hurdles such as the diverse consumer mix, low levels of established distribution networks, infrastructure constraints and political and economic uncertainties are some of the challenges that big formal retail chains have to contend with when setting up in-country operations.

(Source: https://thisisafrica.me)

The “African Powers Of Retailing Report 2015” published by Deloitte tracks the progress of the top African retail performers on the continent. While the top 25 retailers have a limited operational presence in Africa, operating in 21 out of 54 countries on the continent, other countries, such as Algeria, Sudan and Ethiopia, are among the top 10 countries by retail market size but have no listed African Retailer present. Nigeria is the largest retail market in Africa with a retail size of US$122.9 billion as of 2013. However, East Africa – particularly Kenya – is still being identified as the next market for major South African players. Apart from Kenya’s attractive GDP of US$56.1 billion at the time this report was published, it has 25-30% formal retail compared to 60% in South Africa.

It is worthy to note that Nigeria’s retail market is largely fragmented, with the top 6 retailers accounting for barely 2% of sales and 98% of Nigerians shopping in small, local and informal outlets. The importance of the informal economy in Africa cannot be overlooked considering the fact that small, local and informal retail transactions account for 96% in Ghana and 98% in Nigeria and Cameroon. Even in Kenya, the vast consumer base in rural areas still shops at informal outlets, which accounts for approximately 70% of retail shopping. Zimbabwe also has a fragmented retail market and is seeing a recent upsurge in small “tuck shops”.

It further states that as the African economy continues to improve and expand, it is likely that groceries will be a key driver of industry growth across the continent’s retailing industry. The approach that retail multinationals in search of developing their presence in Africa have used in a quest to set up operations in the African retail market is that of acquisitions of local companies or directly establishing their retail stores in-country. How increased access to the informal sector will play out as retailers compete for share of wallet beyond the main urban centres remains to be seen.

Given the above statistics, an avenue which would be worth considering for formal retail multinationals is that of incorporating an informal market operational strategy into their business models. Developing deliberate linkages with this sector of the economy will be a huge game changer and bolster business for both sides of the equation.

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

Poverty mitigation through the Informal Economy

Poverty in Africa has for long been a problem that successive governments have grappled with. Different policies have been drafted and implemented to curb this menace with little impact. Most of these have been centred around job creation policies that have not achieved the desired goals. This is due to the short-term implementation programs which do little to change the lives of those that are targeted.

(Source: http://www.povertyactionlab.org/sites/default/files)

In an attempt to earn a living, those that are trapped in the poverty world look towards various avenues to sustaining themselves as well as providing goods and services that are affordable to the communities in which they operate. The high demand for low quality goods that are often not standardised further makes it difficult for them to sophisticate their operations. This demand and supply factor has seen a rapid growth rate in the size of the informal economy.

Considering that micro and small businesses are set up as a means of making money to get by, it comes as no surprise that the Micro Small and Medium Enterprises 2016 Report, a survey by the Kenya National Bureau of Statistics (KNBS) indicates that the three main reasons the operators of unlicensed businesses establish businesses were due to the lack of another alternative (23.8 per cent), pursuit of better income (23.5 per cent) and a preference for self-employment (13.1 per cent).

Due to the fact that most of these businesses are haphazardly set up, amongst other factors, a vast majority of these businesses have a short life span. The survey noted that 2.2 million small businesses shut down within the last five years. This is 46.3% of the total number of informal businesses. A substantial number of people who establish these sorts of ventures do so without prior knowledge of the fields that they get into with the main objective of starting the business being self-sustenance.

The lack of proper business operational structures as well as insufficient sources of finances to upscale accentuates this problem. As per the survey, the main source of capital for both licenced and unlicensed micro, small and medium enterprises (MSMEs) was through personal and family financing which accounted for 76.3% of these businesses. Access to capital to further grow their businesses is a big obstacle for small businesses. Most of them do not possess business plans due to the random way in which they are established. As mentioned earlier, the absence of internal business structures such as the unavailability of financial records makes it difficult for financial lenders to calculate their level of risk and are hence often turned away.

Policy makers need to dig deeper so as to come up with viable and long-lasting solutions to reduce the rampant poverty levels. A good place to start would be by looking into ways in which they can strengthen informal businesses for they are at the heart of the ecosystem of poor communities. Programs that target these sorts of businesses should focus on building their capacity in the areas of business and financial skills in a way that fosters their long term growth and development.

litualex@gmail.com

Informal Economy Analyst