Should the Informal Economy be the New Normal?

The typical entrepreneur, the average businesswoman, the normal employee in Africa is part of the "informal economy". More than 77% of the non-agricultural workforce of the continent is employed informally, defined as working without paid leave and not receiving social security payments through the employer, who does not pay taxes to the national government. The informal economy is equivalent to about 41% of GDP in Sub-Saharan Africa, ranging from 20% in Mauritius to 65% in countries like Benin and Nigeria. Its elimination or reduction is a key target of economic policy.

Economists are seeing the informal economy as a barrier to growth, because informal businesses tend to stay small to avoid scrutiny. Labour organisations are lamenting the lack of rights for employees. And governments are missing out on substantial tax revenues, which they could use to build up the infrastructure needed to support additional growth.

But there is also a bit of a disconnect in the debate. It is now generally accepted that it is not tax rates per se that keep businesses in the informal sector but overly burdensome bureaucracy associated with going above board. But the pressure on informal businesses to formalise is ignoring that in many cases, formalisation as it is defined by governments and international organisations does not make sense for the business, its employees, or the taxman.

Even if the experience of running a formal business in many African countries could be dramatically improved, many current informal businesses probably don't have the profit margins necessary to cover the associated tax and social security costs. Employees might theoretically benefit from a better defined set of rights when working for formal employers, but enforcement of these rights would be impractical in most circumstances. Critiques of the informal economy also often underplay the flexibility and resilience of this sector, which is of vital importance in the context of institutional and physical insecurity experienced by many Africans.

The way forward is therefore probably not a top down approach which aims to reform government bureaucracy combined with law enforcement pressure on informal businesses to formalise. Rather, a constructive approach would be to acknowledge that most central governments are institutionally ill-equipped to handle the myriad manifestations of the informal economy. Responsibility for regulating and interacting with this sector should probably reside with municipalities and similar local structures. Governments could implement a general exception from taxation and most employer responsibilities for all sole entrepreneurs and small enterprises. Not a big loss, given that these businesses almost universally are acting within the informal sector already.

Local authorities would be better situated to regulate the rights and responsibilities of small businesses, opening up a much-needed income stream as well. Informal businesses already have financial relationships with local authorities in the form of market stall fees and similar charges. These local structures are also more likely to be accountable to members of the informal community, usually the neighbours and relatives of mayors and town hall clerks. Given that the informal economy is already a largely self-organised bottom-up system, emphasising this strength instead of fighting it is the way forward.