Formalizing the Informals

Remembering Tarek Mohammed Bouazizi. Photo: www.foreignpolicy.com

with Marc Schleifer

On the December 6 edition of Marketplace Morning Report, Jeremy Hobson interviewed Robert Neuwirth, who discussed his new book Stealth of Nations. Neuwirth, a journalist and blogger, is seeking to shed light on a major issue often ignored in discussions on the state of the global economy – the informal sector.

In his book, Neuwirth does an excellent job chronicling the complex world of the informal economy: the tens of millions of traders, retail market vendors, entrepreneurs, and small-scale manufacturers who engage in economic activity in much of the developing world.

Yet, in telling the story of the informal sector, Neuwirth, as many others have done, misses the point. While widespread informality should be recognized, it is not a viable path to inclusive and sustainable economic growth.

Actually, the fact that informality is so widespread –according to several studies, as much as 60% of GDP is generated in the informal sector in some countries – is a real problem in today’s globalized economy.

World-renowned Peruvian economist Hernando de Soto has demonstrated the risks and shortcomings of informality, in countries as diverse as Peru, Tanzania, and Egypt.

Disconnected from formal economic institutions, informal market participants have no recourse when their rights are violated and have few prospects to expand their businesses or create jobs for others. Oftentimes, they are mired in what can be called “survival entrepreneurship,” with larger, negative consequences for their countries’ growth and development.

The real story of the informal sector is the story of Tarek Mohammed Bouazizi, a Tunisian fruit vendor whose self-immolation set off the Arab Spring protests. The one year anniversary of Bouazizi dousing himself with paint thinner and lighting a match, driven by frustration with barriers to economic self-sufficiency, is a reminder of the desperate and uncertain conditions in which many of the world’s entrepreneurs survive

As De Soto has shown, red tape, bureaucratic hurdles, and poor governance are the reason so many people are stuck in the informal sector and lack the incentives to join the formal economy. The World Bank’s Doing Business Database documents many of these barriers to formal economic activity.

Neuwirth’s emphasis on trying to decriminalize those in the informal sector should be lauded – efforts to crack down on informal traders or get them off the streets are unlikely to succeed.

But rather than “embracing” the informal sector, we should focus our efforts on improving the business climate and creating incentives for formalization. Registration, taxation, property rights, and licensing reforms, among others, can help informal entrepreneurs transition to small firms that can grow, innovate, create jobs, improve productivity, and take advantage of economies of scale.

In short, while Neuwirth and American Public Media are right to recognize the important contribution that informal entrepreneurs are making to their countries’ economies, this tells only half the story. A more complete view would recognize steps that can be taken to reduce informality, and the need to do so.

Comments are closed.