Recognizing Africa’s Informal Sector

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Mar 27th 2013

In recent years, many African countries have experienced a growth revival, but this has not necessarily generated decent jobs. Unemployment remained high among youth and the adult African population. Little attention has been paid to the role of informal sector in fostering growth and creating jobs. In fact, the informal sector contributes about 55 per cent of Sub-Saharan Africa’s GDP and 80 per cent of the labour force. Nine in 10 rural and urban workers have informal jobs in Africa and most employees are women and youth. The prominence of the informal sector in most African economies stems from the opportunities it offers to the most vulnerable populations such as the poorest, women and youth. Even though the informal sector is an opportunity for generating reasonable incomes for many people, most informal workers are without secure income, employments benefits and social protection. This explains why informality often overlaps with poverty. For instance, in countries where informality is decreasing, the number of working poor is also decreasing and vice versa.

Factors explaining the proliferation of informal economy in Africa

The informal economy is often associated with increasing poverty and weak employment conditions. According to the African Development Bank, middle-income countries have smaller informal sectors but higher unemployment rates than the poorest countries. By investing through informal channels, African entrepreneurs seek to reduce costs related to wages, retirement pensions and other social benefits.

Beyond poverty and social issues, the prevalence of informal activities is closely related to an environment characterized by weaknesses in three institutional areas, namely taxation, regulation and private property rights. Higher taxes and complicated fiscal process may prevent informal sector operators from formalizing their activities. Long requirements for registration as well as licensing and inspection requirements are also barriers faced by the informal sector.

Moreover, limited access to capital is an important constraint for operators working in the informal sector. Lack of skills, education and training are also impediments to the formal sector in Africa. Other factors include the limited access to technology and poor infrastructure. Furthermore, the informal sector doesn’t seem to be on the development agenda of African countries or their multilateral development partners.

Promoting Africa’s informal sector

Organizing the informal sector and recognizing its role as a profitable activity may contribute to economic development. This can also improve the capacity of informal workers to meet their basic needs by increasing their incomes and strengthening their legal status. This could be achieved by raising government awareness, allowing better access to financing, and fostering the availability of information on the sector.

Authorities’ awareness: Policy-makers in Africa should recognize the important role informal sector companies play in the economy. Associating the informal economy to criminal endeavours or tax evasion is not a good way to formalize the sector in Africa. There is a need for African governments to coordinate their policies and strategies in order to support the formalization of the sector. Effective regulatory framework, good governance, better government services, improved business environment, and improving access to financing, technology and infrastructure are essential in this process. In that regard, development partners have pledged their commitment to support the formalization process. This includes mainly the promotion of social protection to workers in the informal sector and support to small and medium-sized companies, which account for the bulk of Africa’s informal economy.

In addition, African policy-makers should be aware of the heterogeneity of the informal sector. According to a recent study on West Africa, governments should distinguish between small and large informal firms. The latter category plays an important role in the economy comparable to the role of major formal firms. Thus, African governments should adopt specific policies to bring large informal firms under formal regulation. For this, a systematic approach should be adopted in order to enforce a comprehensive regulatory regime including, for instance, registration for a formal tax regime.

Better access to financing: Limited access to funds is one of the major factors explaining the development of the informal economy. Facilitating access to formal financing channels such as micro-credit could be an overriding step to encourage informal entrepreneurs to shift toward more formal economic activities. However, raising the awareness of large conventional commercial banks of the potential of the informal sector is also essential.

Improving access to information: The fact that the informal sector has for a long time been neglected by policy-makers has not helped in generating knowledge on this sector. For instance, informal activities are often invisible in official statistics. In order to analyze the contribution of the informal sector in the economy, it is important to collect and maintain relevant information. This includes a wide range of information, such as the characteristics of actors, tax collection, impact on employment, working conditions, and productivity of informal companies.


Comments

Kapotwe Paul - Zambia 04/04/2014 00:23
Many developing governments are increasingly focusing on growth from Foreign Direct Investments which they count in terms of number of jobs created for their citizenry and some taxes, if any, which are rarely and honestly declared. It appears developing govts cannot find time to register and count the thousands of informal enterprises whose combined worth may not, in their view, justify the cost for formalisation in the short term. What they forget to measure is that FDI comes with very unfavourable Development Agreements like tax holidays, forex retentions et al!
Amos Ogenrwot - Uganda 26/11/2013 09:10
I agree with Lee Walters-France, basing on my findings in my research report, I managed to form and register a CBO (community based organization) consisting of twelve members. the main activity is to mobilize resources (money) and lend to small scale entrepreneurs in the region.(northern region). it is working very well and hoping to grow to a bigger MFI. thanks
Anietie Umoh - Nigeria 20/07/2013 12:18
A recent study by SMEDAN shows that 99% of enterprises in Nigeria are micro-enterprises. So the socio-economic transformation of Nigeria can only be achieved if there is cognate effort to develop and improve the productivity of micro-enterprises
paul kapotwe kapotwe - Zambia 04/07/2013 22:30
Professor, it is also true that informal sector entrepreneurs are "growth-averse", they fear to expand their businesses as expansion goes with new costs and therefor formalization becomes a costly prospect, so they opt to remain small and subsist on minimal margins....a grocer we lived close to when I was I was in early primary school has operated at the same level way till I was old enough to write about enterprise development.
lebogang maggy - South Africa 21/05/2013 15:04
strategies to strengthen the informal sector
Ghislaine-Dahlia Kouamé - Côte d’Ivoire 08/05/2013 08:58
it is clear that informal sector in Africa needs some improvements.A regulation of this sector can change everything.
Ethel del Pozo - Vergnes - United Kingdom 02/05/2013 14:47
Dear Mr. Ncube,

Together with many researchers, practitioners and business people, we came to the same conclusion, see our recent book http://pubs.iied.org/pdfs/16521IIED.pdf . We really need to better understand to improve the informal sector. This is a new multistakeholdes work we are initiating. Happy to give further information.
Ethel del Pozo - Vergnes
International Institute for Environment and Development
London
Nathaniel Boso - United Kingdom 23/04/2013 17:30
I do appreciate the views of Professor Ncube regarding the informal sector and its potential to end poverty in Africa. My question is: would improvement in “institutional areas, namely taxation, regulation and private property rights" and market-supporting infrastructure increase business formality (thereby decreasing informality and poverty) in Africa? Given the situation in Africa now, I doubt this will happen, and people are going to continue to undertake insecure jobs and poverty is certainly going to continue to rise in Africa. The bigger headache is that jobs in the entrepreneur-led firms in the formal sector in most African countries are equally insecure with rampant incidence of low wages and non-payment of social security benefits. The antecedent is clear: African entrepreneurs are more Kirznerian in their approach to business management and tend to pursue unreasonable profitability objective such that the welfare of employees and the wider community are often ignored. For example, it is typical that employees in entrepreneur-led firms in Africa work long hours beyond the legally allowed 8 hours a day without being paid overtime allowances. Why is this so? I speculate that it is due to poor law enforcement and inability of African governments to implement real life policy initiatives . Law enforcement in Africa is not something one should think will improve anytime soon, and I doubt the capacity of African governments to develop any good poverty reduction policy. My view is that promotion and support for community-based entrepreneurial ventures/enterprises is a key to poverty reduction in Africa. With community-based enterprises, group of individuals may be supported financially to start a formal profitable venture such that the profit that accrues belongs to the community (and not private equity holders), and this proceeds could then be used to enhance rural livelihood. Because the enterprises are community based, locals get jobs that are well paid and can itself contribute to improvement in local surroundings. This community-based enterprise stuff is currently being practiced in other developing spots such as India and Latin America. The Chinese has practiced a similar concept called Town and Village Enterprise (TVE) and this has helped transformed many rural communities in China from severely poor to middle-income communities. Of course a key challenge is lack of managerial and technical expertise to manage the enterprises, but this is where development agencies such as AfDB can come in to help with training and personnel development initiatives. My view is simple: central governments and their capacity to improve the lots of local communities is not working, and it is time new approaches are tried to take people out poverty in Africa. Of course, my view here and that of Prof Ncube are speculative and are hardly supported by any robust empirical research, which is itself a big problem in Africa: we do not undertake good empirical studies to understand our socio-economic problems and how to solve them and it is time we develop our academics and professionals with skills to help better understand our problems.
Dick Kawooya - Uganda 18/04/2013 16:17
Recognizing the importance of the informal sector in Africa by a senior official of the afdb is an important step. Without a doubt the informal sector dominates in many African economies. But as rightly pointed out by Professor Mthuli Ncube, there are hardly any deliberate government policies to foster growth in the sector. Where they exist, the policies are incoherent at best. The primary reason being most governments don't know exactly what to do with the informal sector. In all likelihood pursuing a policy of formalizing, whatever that means, will fail because not all informal sector actors necessarily want to formalize. Indeed not all informal sector actors are poor. Finally not all informal sector actors are permanently situated in that sector. Many move back and forth between formal and informal. I think we need to acknowledge that informality in Africa has been the norm rather than the exception and will continue to be into the future.
Lee Walters - France 02/04/2013 22:45
It is true that the informal sector brings income. However it is still informal. I am of the opinion that if those in these sectors had the choice they would not be in these sectors. Developing people would empower them and move them out of poverty. It is better we prevent a crisis than to let it happen before we bring in humanitarian assistance.
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Mthuli Ncube

Professor Mthuli Ncube is the Chief Economist and Vice President of the African Development Bank, and holds a PhD in Mathematical Finance from Cambridge University, UK, on “Pricing Options under Stochastic Volatility”.

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