Recently we were asked whether the informal economy might prosper in the long term in the developing world, or if it should be curbed as a hindrance to development. Informal business accounts for 35-50% of GDP in many developing countries and more in some cases. Paradoxically perhaps, the sector contains both entrepreneurial spirit and the struggle for subsistence.
From one perspective, informal businesses have an unfair advantage in avoiding taxation. On the other hand, these busineses lack legal rights, and are unable to access public services or formal sources of credit. So what is an appropriate policy response?
The solution is neither to encourage nor suppress informal economic activity but rather to facilitate the transition of informal businesses to the formal sector and reduce barriers for all business (formal and informal). Opening routes to formality creates new opportunities for the poor to realize their potential and raise national competitiveness. Acquiring formal status allows entrepreneurs to access formal markets, invest with security, obtain new sources of credit, and defend their rights.
An effective route to formality, however, requires more than registration and enforcement. It requires the tearing down of barriers at the origin of informality to improve the business climate for all entrepreneurs. Lowering barriers increases business opportunities while facilitating compliance.
Simply put, informal entrepreneurs have tremendous potential, but in order for them to realize that potential they must be allowed to make the shift into the modern market economy. This will give the same opportunities to all entrepreneurs and create higher-quality new jobs.
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