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Working Paper 159 - Why do some Firms abandon Formality for Informality? Evidence from African Countries?
The informal sector is a significant part of African economies. While the share of the informal economy has been going down, it remains relatively high with an average of approximately 40% across the continent (Schneider et al. 2010). There are several factors that account for the presence of such a large number of firms and workers that are not formally registered with local or central governments.
Whatever the reasons, the continued presence of a large number of enterprises in the informal economy is a major concern for policy makers given its implications for the productivity of the enterprises, efficacy of government policies and finance, and effects on workers’ welfare. Formal firms are significantly more productive than their informal counterparts (Aterido et al. 2007; Gelb et al. 2009). By operating in the informal sector, governments are less able to levy taxes on these enterprises. This is a major concern given the limited tax base of most African countries, and has implications for the adequate financing of infrastructure and other public goods. There is also a general efficiency argument for increasing the percentage of firms with formal status. For instance, making the process formality easier can lead to a greater competition in the private sector. This ease of entry leads to lower product prices, greater efficiency, and increased welfare. Employees may also benefit because of the association between higher labor standards and the formal sector (Fortin et al. 2000; Galli and Kucera 2004).