Recognizing Africa’s Informal Sector
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.
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”.