Driving through any city in sub-Sahara Africa provides immediate evidence of the pervasiveness of the informal economy (IE). From the ubiquitous street vendor to the domestic worker, from the large business under-reporting its employees to the craftsman working alone or with a handful of aides, the IE spans a broad array of situations. On average the IE accounts for 40% of the GDP and 60% of the non farm labor in Black Africa*.
This informal economy will not spontaneously retreat. Its dynamics stem from a set of fundamental factors, including: a growth rate too low to absorb the bulging working age population, education systems failing to deliver the skills the formal economy requires, a heavy tax and regulatory burden that makes compliance costly, weak States unable to enforce their own laws as well as a “free rider” culture that put little social pressure on respecting the rules as a condition of an orderly society.
Still, the IE poses a real threat to African economies. With productivity levels 50% below that of formal companies in the same industries** and no access to credit to fund new investment, due to the lack of property titles, informal activities reduce the growth potential of the whole economy and hardly break the poverty cycle. Tax receipts shrink drastically which leads to an over taxation of the formal economy. In addition, ignoring the regulation gives businesses in the IE a 15% to 25% cost advantage** over businesses in the formal economy. Lastly, the whole society is left worse off; workers get lower wages and social, health and safety benefits while consumers gain access to lower quality or unsafe products.
An effective economic development agenda must, therefore, design the process and tools that help transition activities in the IE towards the formal economy. That entails (i) an absolute priority given to labor intensive industrial projects, (ii) a thorough overhaul of the education system to align the skill supply to the demand of the formal economy, (iii) a smart reduction of the tax and regulatory burden and (iv) a visible improvement of the public governance in order to fight corruption and create competent and fair institutions.
These steps will result in a reduction of the benefits of operating in the IE and boost the legitimacy of the State, which is a pre-requisite to the consent to taxation and to the rule of law that underpins the social pact.
* ILO: “the informal economy in Africa”, 2009 paper.
** Research from the McKinsey Global Institute.