PSD Blog - The World Bank Group

How relevant is the location of informal businesses for policy?

A distinction is often made between informal firms operating within, versus outside, household premises. In some sense, the former represent the quintessential informal firms beset with a number of problems, such as low efficiency, etc. Policies aimed at bringing informal firms into the fold of the formal sector could therefore be expected to have a bigger impact when targeted toward informal firms operating within, rather than outside, the household.

A survey of informal firms in Ivory Coast, Madagascar and Mauritius conducted by Enterprise Surveys provides some support to this idea. The survey shows that 81 percent of the firms in Ivory Coast, 72 percent in Madagascar and 49 percent in Mauritius operate within household premises. The figures below show the percentage of firms that report various benefits from registering. Overall, a larger percentage of firms located within household premises expect the various benefits from registration. These preliminary findings suggest that understanding the types of informal firms that operate within and outside household premises could be an interesting area for future research.

 

Bringing Finance to Pakistan's Poor

Yesterday I attended the World Bank's book launch of Bringing Finance to Pakistan's Poor: Access to Finance for Small Enterprises and the Underserved. The authors, Tatiana Nenova and Ceclie Thioro Niang, interviewed 10,000 households from across Pakistan's geographic and socio-economic landscape, including both men and women.

In general, Pakistanis are underserved by both formal and informal channels of finance. Only 14 percent of the total population has formal access, while just over 59 percent have access to either formal or informal finance. As the chart above illustrates, this is quite low compared to Bangladesh (32% formal access), India (48%) and Sri Lanka (59%). Small and medium enterprises, which account for 30% of GDP and 78% of jobs, only account for 16% of the country's overall credit.

Informal Sector Comparison: Manufacturing vs Services

I have been comparing the differences between manufacturing and services firms in the informal or unregistered sector. There is a rich literature on how and why these firms differ, but it is based on firms in the formal or registered sector. It’s a moot point whether differences between manufacturing and service firms in the formal sector also hold for the informal sector. For example, differences in scale economies between service and manufacturing firms are known to be important for the formal sector, but this is not immediately obvious when comparing these firms in the informal sector.

“Unwilling” Entrepreneurs

The common perception of the informal sector is that unregistered businesses are not as efficient as registered or formal businesses. One proposed reason for this is that, by not being registered, informal businesses face severe hardships in accessing finance, markets, public services and government programs. Hence, the usual policy response to informality is simple: try and encourage informal businesses to register.

However, another problem in regards to informal firms may be the underlying motivation for starting the business in the first place. There are many informal businesses that are started not because the owner sees a good business opportunity, but because he or she cannot find a satisfactory job (“unwilling” entrepreneurs). A survey of informal firms conducted by Enterprise Surveys shows that 46 percent of informal firms in Ivory Coast, 39 percent in Madagascar and 31 percent in Mauritius were started because the (largest) owner could not find alternative employment opportunities.

Access to finance: Mexico edition

The World Bank has released its latest Finance and PSD Impact Newsletter. The paper looks at the impact of large-scale bank expansion in Mexico, evaluating the effects of increased access to finance for low-income borrowers.

The authors analyze the expansion of Banco Aztecta in 2002. The bank opened over 800 new branches inside the consumer goods retail stores of its parent company, Grupo Elektra. These new outlets catered primarily to low and middle income clients. The authors find a clear correlation between the bank's expansion and income growth among lower income groups.

The key findings to the report include:

1. Bank openings increased the proportion of working age adults who own informal business by 7.6 percent
2. The opening led to a higher proportion of women working as wage-earners
3. As a result of the expansion, female incomes increased by 9 percent and male incomes rose by 5 percent

The authors also note what the bank openings did not achieve: no effects on the establishment of formal businesses, and no increases in female-owned informal businesses.

Men benefit from greater financial access by starting more informal businesses; women seem to find more work, and earn higher wages. With respect to women, it would be interesting to know if these findings are the result of women borrowing less, or because they are using their borrowings to fund other (non-business) activities.

Freeing up labor markets in Latin America

Fellow blogger Dave Kaplan makes a cogent point in a note on labor regulations in Latin America. He points out that on a net basis, making labor regulations more flexible in most countries will result in a net gain in employment. More workers will be fired, but even more workers will be hired as a result of increased flexibility (Table 1 below the jump). Only one country in the study (Nicaragua) would see no net gain, and a number of countries would see large net gains (e.g. Colombia and Paraguay).

An exceedingly simple answer

Oscar Calvo is an economist who works on economic policy for the Latin American and Caribbean region here at the World Bank. He shared with me some interesting research on the determinants of informality in Peru. Oscar and his team conducted a survey of 802 micro and small firms, both informal and formal, and came up with the following chart (below the jump) on the benefits of being registered to pay taxes. (The RUC number is the firm’s tax ID).

Formal firms with informal workers

In my last post, I claimed that “it is common for formal firms to have many informal workers.” How do I know that?

Joyce Sadka and I have been doing some work using data from a labor court in Cuautitlán, which is located just outside of Mexico City. Each data point represents an individual who claimed to have been fired from a formal-sector firm without cause.

As of now we have data on about 2,000 such cases filed in 2002. Most cases settle or are dropped, but 245 cases went all the way to a judge’s ruling. A judge’s ruling hopefully gives us an unbiased look at the facts of the case.

What prevents informal firms from becoming formal?

An earlier post on this blog talked about the benefits to informal or unregistered firms from registering. Using data on informal firms in Côte d’Ivoire, Madagascar and Mauritius (Enterprise Surveys), I argued that a majority of the informal firms believe that registration brings real benefits, especially those associated with better access to finance and markets.

The question that arises then is why don’t firms register? Clearly, there must be some costs or impediments to registering and these costs outweigh the expected gains to firms from registering. I discuss below the sorts of costs that the informal firms associate with becoming formal.

What does formal mean anyway?

I can’t stop thinking about Mohammad’s post on the benefits of formalization.

His post lists nine potential benefits to firms from formalization. You can check out the post to see the complete list. I was particularly interested in the potential benefit of “Better access to workers.”

As a labor economist, I think a lot about the benefits of being a formally-registered worker. In many countries, being formally registered entitles the worker and the worker’s family to government-provided health care. Maybe a pension when the worker retires as well. Firms might find it hard to attract workers if the workers don’t get these benefits.