Saylor.org's Comparative Politics/Informal Economies and Black Markets
- 1 Overview
- 1.1 Our Approach to Studying the Informal Sector
- 1.2 Characteristics of Informal Businesses in West Africa
- 1.3 Institutional, Regulatory, and Sociocultural Environment
- 1.4 Costs and Benefits of Informality: Productivity, Living Standards, and Tax Revenue
- 1.5 Main Conclusions and Recommendations
- 1.6 Note
- 1.7 References
Informality usually connotes small and unorganized producers operating on the fringes of the formal economy. In West African countries, however, the normal situation is generally reversed: dynamic informal sectors dominate stagnant formal economies. Moreover, in these countries, small operators coexist with very large and politically well-connected informal enterprises and well-organized networks. This study is the first to describe and analyze large informal firms in a systematic way. In addition to the novel distinction between large and small firms, the originality of this study resides in its eclectic methodology and collection of original data. A key conclusion is that determinants and appropriate policy responses differ between “large” and “small” informal operations.
The informal sector is a central issue for African economic development, yet relatively little is known about it. This volume endeavors to improve our understanding of the complex reality of informal sector firms in West Africa. The book provides detailed description and analysis of the characteristics and functioning of informal sector firms, the causes of the pervasiveness of these firms, the relations between formal and informal firms, the consequences of informality for economic development, and appropriate policy responses.
This study focuses on the urban informal sector in three capital cities: Dakar (Senegal), Cotonou (Benin), and Ouagadougou (Burkina Faso). These three countries have important differences and, as a group, are quite representative of francophone West Africa and, to a lesser extent, West Africa as a whole.
We employ a mix of quantitative and qualitative approaches using data obtained from our own surveys of 900 firms in the three cities, interviews with knowledgeable stakeholders and participants, and all available secondary data. For the surveys, we designed our sampling strategy to include three distinctive categories of firms: formal, small informal, and large informal. In addition, we developed a comprehensive definition of informality to reflect its complexity and heterogeneity. Our definition (chapter 1) covers six components of informality, whereas previous definitions are generally limited to a binary classification based on one or two indicators. Our results for West Africa corroborate many findings from earlier studies, particularly for small informal firms. In addition, we break new ground by shedding light on the large informal sector and the institutional and sociocultural factors shaping it.
Our Approach to Studying the Informal Sector
Understanding the causes and consequences of informality is crucial given that the informal sector plays a dominant role in West African economies, particularly with regard to employment. Chapter 3 describes the informal sector in the three countries and presents their shares of employment and of total and sectoral gross domestic product (GDP) based on national accounts data. Despite the limitations of official estimates, which exclude large informal firms, they reveal that the informal sector accounts for the majority of GDP and 90 percent or more of employment. In fact, formal employment in the private sector is truly scarce, at 1 to 5 percent of the labor force.
The vast majority of previous studies of the informal sector in Africa focuses on very small enterprises, usually individually operated, such as street vendors and craft smen. While it is certainly true that most informal activities are very small scale, the informal sector is, in fact, far more complex and encompasses some very large operators as well as sophisticated informal networks linking seemingly isolated microenterprises.
The informal sector in Africa diff ers in particular from that in Latin America. The groundbreaking study of the informal sector in Latin America (Perry et al. 2007) does not include any discussion of large informal firms, although it does note that some large formal firms underreport sales or employees. Th e evidence from Latin America also indicates that a substantial share of workers voluntarily exit paid employment in the formal sector and form their own small informal businesses, which is rare in West Africa.
The literature’s focus on small operators has entailed data collection strategies that focus on household-based enterprises and the labor market. This approach has, by definition, excluded the larger firms. Empirical studies of the informal sector have largely followed the pioneering approach of the International Labour Organization (ILO 1993, 2002). The ILO defines informality by firm size and lack of registration, effectively confining the sample to household and small enterprises. Another strand of the literature uses World Bank Investment Climate Assessment (ICA) data and other similar databases (Gelb et al. 2009; La Porta and Schleifer 2008, 2011). ICA surveys provide much useful information, but they would be better described as private enterprise surveys, in principle covering both formal and informal firms, but in practice excluding much of the informal sector, namely the large informal firms as well as microenterprises. The World Bank also conducts “informal” and “micro” surveys to capture the informal sector. These surveys, however, are limited to small firms, thus excluding the large informal sector.
We argue that informality is a continuum, with even largely formal firms often engaging in some informal practices. Recently, some authors have recognized that informality is a matter of degree, best captured by a range of indicators (Steel and Snodgrass 2008; La Porta and Schleifer 2011; Guha-Khasnobis and Kanbur 2006), but none has proposed or implemented operational definitions. The characteristics of informal firms are indeed rather complex and may be captured best through the use of multiple criteria. Some firms are registered and pay taxes but substantially underreport sales and profits (Dabla-Norris, Gradstein, and Inchauste 2008; La Porta and Shleifer 2011). Our survey results also show that a large number of firms underreport sales.
In chapter 1, we provide a definition of informality using six criteria: size, registration, honesty of accounts, fixity of workplace, access to credit, and tax status. Although these six criteria are more comprehensive than what others have used, they do not capture all dimensions of informality, such as management practices and participation in social security programs. These six criteria are combined to create levels of informality depending on how many of the six a particular firm meets. At the bottom of the ladder are firms that are completely informal—firms that do not fulfill any of the criteria defi ning formality. The second level consists of firms that fulfill at least one of the criteria defining formality, and so on, with the last level being firms that meet all criteria and are completely formal. The two extremes of purely informal and purely formal are rare.
We further distinguish two categories of informal firms: large and small. Large informal firms are comparable in size to those of the modern sector but behave informally in other respects. These firms satisfy all of the six criteria for formality used here, except for one: their accounts are not accurate. Large informal firms differ from formal firms in less tangible respects not covered in our criteria, such as management structure and personal attributes, as discussed in chapter 4.
Given the complexity of the informal sector and the difficulties of obtaining accurate information, we used three types of data sources. First, we made use of standard national accounts and other public databases, for example, those from customs, fiscal authorities, and national statistical institutes. While useful for cross-checking and providing an overview of the significance of the informal sector, these databases do not enable in-depth analysis of informal sector fi rms. As a second step, we conducted our own surveys. Third, we also conducted interviews, which allowed us to collect qualitative information to supplement the quantitative data from our surveys. We interviewed key stakeholders and experts on the informal sector from both public and private sectors.
Regarding our surveys, in order to have a mix of formal, large informal, and small informal firms, we used a stratified sampling strategy, described in chapter 2. That is, we sought random samples within three-by-three categories composed of (a) formal, small informal, and large informal enterprises and (b) industry, commerce, and other services. A first set of surveys was conducted in 2007, with a sample of 300 enterprises in Dakar, Ouagadougou, and Cotonou, for a total of 900 units surveyed in the three cities combined. In 2009, follow-up surveys and interviews were conducted with a smaller number of firms in the three cities, focusing on large informal and formal firms.
Characteristics of Informal Businesses in West Africa
We compared the characteristics and functioning of informal and formal firms from a variety of perspectives: size, social and demographic attributes of firm managers, access to credit, participation in global markets, capital investment, access to public services, registration, quality of accounts, fixity of workplace, payment of taxes, and participation in social security systems.
Our most important findings concern the distinction between large and small informal operators. As noted, in West Africa, large informal firms and trading networks coexist with small operators, but little is known about who is involved, the sectors in which they operate, and the nature of their businesses. This study presents factual information on the large and small segments of the informal sector and the formal sector.
Large informal firms are fundamentally different from both formal and small informal firms, while at the same time resembling each of them in some respects. They are discussed in detail in chapter 4, using case studies of firms and sectors where they play a major role. These sectors include import-export trade, domestic wholesale-retail, transportation, and construction. For example, in Senegal, one trader is estimated to control more than a third of the imports of rice, the main food staple in the country. These large informal entrepreneurs often began as small operators with minimal education but became very wealthy and influential thanks to superior entrepreneurial ability and effort, along with assistance from ethnic and religious trading groups. In volume of sales and other measures of activity, these firms do not diff er from their formal counterparts. Moreover, they are registered and well known to the authorities. Yet they continue to underreport sales massively and to maintain fraudulent accounts. In their family-based organization and management, they are very much like small informal firms. Typically, a single person (usually a man) controls all major functions (human resources, accounts, finance, and marketing), in contrast to formal firms that have separate departments for each activity. The owners’ personal and business assets and liabilities are not clearly separated.
In addition, these enterprises are fragile insofar as the owner may dissolve the business because of a conflict with tax or customs officials or reappear under another name, when identified by the tax authorities.
Large informal firms are very difficult to identify. We were able to identify and understand the operation of these firms through interviews with some of the entrepreneurs as well as with government officials and other knowledgeable people. We also explored the operations of these large firms in Senegal by comparing firm-level imports tabulated by customs with the same firm’s level of total turnover, as reported to the fiscal authorities. In many cases, firms’ imports far exceeded their reported total turnover, strongly suggesting underreporting of sales.
For small informal firms, our survey results largely confirm the standard findings in the literature (chapter 5). Firm size is tiny and dominated by selfemployment. Most firms are registered somewhere, usually with municipalities and the Ministry of Commerce, but rarely with the fiscal authorities. The level of education is generally low, with relatively high (but still low in absolute terms) participation of women. Access to bank credit is almost nonexistent due to insufficient documentation; small informal firms resort to unofficial credit markets with onerous interest rates. Use of information and communication technologies (ICTs) is limited. Small informal firms are concentrated in many of the same sectors as larger informal firms: commerce, handicrafts, transport, and new and used clothes. Small informal firms sell low-quality products to other microenterprises and low-income households in a highly competitive market. They rarely export. Small informal firms also operate in a completely unregulated and competitive labor market, and employees have no social security protection.
Chapter 5 also compares the characteristics of formal, large informal, and small informal firms. Formal firms differ from informal firms in all of the above characteristics; that is, they are considerably larger, are registered with the fiscal authorities, pay regular taxes, have managers and workers who tend to be more highly educated, have greater, although still surprisingly limited, access to formal credit (by international standards), make use of ICT, and are somewhat more export oriented.
Large informal firms’ characteristics tend to fall somewhere in the middle, between formal and small informal firms. As noted, the organizational structure of large informal firms differs little from that of smaller informal firms. Volume of- sales data suggest that large formal firms are generally as big as formal firms, but they have far fewer permanent employees, except in Cotonou. Cotonou is, in general, rather different from the other two cities because of its role as a hub for regional smuggling, as described in chapter 9. Many of the major smuggling enterprises are very large-scale operations, particularly in the used car market, also described in chapter 4.
The literature on the informal sector often notes that a major drawback of informality is lack of access to public services. We largely corroborate this result but also find that formal firms suffer even more than informal firms from the deficiencies of infrastructure; in some cases, formal firms have longer wait times for connections to utilities than small informal firms. Moreover, formal and informal firms share the same highly negative view of the business environment.
Relations between formal and informal firms are complex, with cases of both competition and cooperation. Many formal firms rely on informal distributors. Commerce and construction involve well-developed ties and subcontracting between formal and informal operators. Customs clearance for imports illustrates these interactions. Many unauthorized customs clearance agents work in this sector, in collusion with legally authorized agents. The informal actors clear merchandise from the port at much lower costs, using the authorized agent’s seal in exchange for a side payment to the latter. Similarly, in the construction sector, government procurement and other large contracts are usually reserved for formal firms, but these firms then subcontract out most of the work to informal firms.
In other areas, competition from informal firms, particularly importers, undermines formal producers and distributors. A major part of the informal sector revolves around smuggling to evade import barriers designed to protect local manufacturers, for example, in sugar and clothing. Many other goods are smuggled in, notably used cars, used clothes, and pharmaceuticals (including counterfeit drugs), undercutting formal distributors of these products who pay import duties, particularly in Senegal. Chapter 9 describes the operation of smuggling networks, focusing on Benin and Senegal, provides estimates of the magnitude of smuggling, and analyzes the distortionary domestic policies that foster these practices. Th ese smuggling operations are also facilitated by kinship networks of traders that span national borders, as described in chapter 8.
Institutional, Regulatory, and Sociocultural Environment
As detailed in chapter 4, the informal sector dominates the economies of West Africa and is expanding, to the detriment of the formal sector. Our view is that the institutional and social environment plays a crucial two-way role in fostering the pervasiveness of the informal sector. On the one hand, the institutional setting is a major determinant of informality. Weaknesses in the business climate and regulatory framework induce firms to opt for informal sector status. Moreover, traditional African business practices often conflict with largely imported Western rules and norms. On the other hand, the dominance of the informal sector further undermines compliance with rules, regulations, and codes of conduct compatible with a level playing field.
Chapter 6 focuses on the legal and regulatory environment and how it affects the decision of firms to operate in the informal sector. Formal businesses are subject to a proliferation of taxes, including several types of income tax, wage taxes, taxes on equipment and buildings, and various registration and license fees, resulting in numerous duplicative taxes that cumulate to a high incidence and imply onerous compliance costs. Business law in francophone Africa, including the three countries under study, is in principle governed by OHADA,1 an intergovernmental structure modeled on the French legal system. OHADA imposes a minimal set of recordkeeping for all firms that is feasible even for small firms. Nevertheless, the governments do not enforce these rather minimal regulations, allowing firms to pay the lower lump-sum presumptive taxes without any record-keeping obligations. This reflects weak enforcement capabilities. Another major problem is a lack of cooperation among government agencies, particularly between customs and tax authorities. In fact, as noted earlier, in chapter 4 our own analysis of customs and tax databases indicates massive underreporting of incomes in Senegal. Also, there are a large number of underfunded and ineffective government agencies with overlapping and unclear mandates.
Due largely to these problems, indicators of the business climate are poor. In this regard, our surveys and interview results for the most part corroborate standard rankings and indicators of the business environment, such as the World Bank’s Doing Business rankings and the World Economic Forum’s Global Competitiveness Report. Waiting times for connection to utilities (water, electricity, telephone) are often very long, and service is expensive and unreliable. Frequent power outages continue to be a major disruption to formal and informal businesses alike.
State failures also include corruption, bureaucracy, and the establishment of state rent-seeking systems, as discussed extensively in chapter 6. Corruption in all rungs of society contributes to the flourishing of large informal firms. Often, such firms are politically well connected, which offers them some impunity. They freely challenge court decisions that go against them, and the press often reports corruption scandals in the courts. Large informal actors are supported by a chain of collusion that involves customs, the administration, and the courts.
The weaknesses of the state are also manifest at the level of tax collection. Fiscal authorities disproportionately target formal firms. Many formal sector managers complain that, once the fiscal authorities identify them as significant taxpayers, they are subject to repeated audits and upward adjustments in payments (chapter 5). Tax officials themselves acknowledge their focus on formal firms. In an environment rampant with corruption, informal firms seem to possess greater flexibility in their relations with the government. Many firm managers also believe that underreporting of income is pervasive and not punished by the government.
The regulatory and state failure issues that emerge clearly from our surveys and interviews are fairly well documented in the literature on African development. Social and cultural settings are less studied by economists, yet also play a prominent role in the spread of the informal sector in West Africa, as we illustrate in chapter 8. In particular, ethnic and religious networks substitute for the state provision of public goods. Ethnic and social networks are a form of “social capital,” which can have positive as well as negative effects on economic development. On the plus side, social networks create bonds of trust that enable contract fulfillment, access to financing, and information exchange without documentation or official involvement. Kinship groups play a particularly important part in international trade, helping to overcome transaction costs created by lack of information and differences in business practices across countries. Kinship networks have a major role in informal cross-border trading in West Africa, as described in chapter 9. On the negative side, however, social capital in general and informal networks in particular can be exclusionary, accepting or even promoting antisocial behavior and violation of the rules and norms of the formal economy. Again, this is clearly manifested in West Africa insofar as kinship networks are heavily involved in illegal activities, particularly smuggling and tax evasion. Overall, ethnic and religious networks are particularly significant in West Africa because of the combination of weak formal institutions and the continuing importance of kinship ties dating from the precolonial era and the resistance to colonialism. Chapter 8 notes some common features of the Mouride and Yoruba groups and relates them to the informal sector practices discussed in other chapters of this book.
Chapter 8 also illustrates the effects of kinship groups through case studies of the Mourides in Senegal and the Yoruba in Benin. In both cases, there is a close connection between the informal sector in general and trading in particular. To this day, trading is the foremost activity of the informal sector, as seen in chapter 2, involving both domestic and cross-border dimensions. The trading networks of the Mourides extend to Europe, Asia, and North America in addition to Africa. Th e Yoruba’s trading sphere is confined largely to West Africa. The interplay of historical, cultural, and economic factors is important in understanding the central role of informal trading activities in West African economies. While group solidarity and mutual trust enable the expansion of commercial activities, the political and economic influence of these groups is not entirely benign. Their main markets, such as Touba and Sandaga in Senegal and Dantokpa in Benin, are largely off -limits to the government, enabling these groups to engage in smuggling and tax evasion in plain view of the authorities.
Chapter 9 investigates smuggling in detail, with a focus on trade between Senegal and The Gambia and between Benin and Nigeria. The characteristics and operation of this informal trade are described. The causes of this trade are varied, but the main drivers are policy distortions causing price differentials across borders, combined with long-standing ethnic and religious ties transcending national borders (as described in chapter 8), long porous borders, weak enforcement, and the involvement of influential political actors.
Costs and Benefits of Informality: Productivity, Living Standards, and Tax Revenue
The costs and benefits of informality can be viewed from the perspective of an individual entrepreneur or from the point of view of society as a whole. The former refers to the decision of a firm to formalize or not, whereas the latter concerns the overall economic and social consequences of the informal sector.
Regarding the former, as discussed in the previous section, weak state enforcement capabilities, inadequate provision of public goods, and lack of an effective and transparent regulatory framework are critical for firms’ decisions. A hostile environment can push an agent into the informal sector. Formalization means greater access to public services but also requires compliance with regulations and payment of taxes. Participation in the formal sector engenders both fixed costs (related to registration and normalization of formerly informal activities) and variable costs (taxes and contributions for social security), as pointed out by Levenson and Maloney (1998). Our results show that these institutional factors are very important for explaining the expansion of the informal sector (especially chapters 4 and 6).
The remainder of this section examines the larger question of the social effects of informality. Among the outcomes of informality, the productivity issue is critical. As many other studies have found, the productivity gap between formal and informal firms is large. Our results unambiguously corroborate this fact in the three cities, as reported in chapter 7. In addition, when informality is broken down into six levels, as described previously, formality and productivity are strongly and positively correlated. This finding is robust with respect to alternative definitions and correlates of informality and is confirmed using alternative multiple regression specifications.
The correlation between productivity and informality may reflect two-way causation. Low productivity may lead to informal sector status through selfselection of firms by quality of management. The most talented managers choose to formalize because they reap greater benefits from access to public services, provided government has the necessary enforcement capabilities and the business environment is sufficiently favorable (Gelb et al. 2009). Reverse causation running from firm status to productivity could be due to the reduced access to public services that informality entails. Informality also prevents companies from acquiring modern management skills and worker training, further reducing productivity, although Grimm, Knorringa, and Lay (2012), using West African survey data, are able to distinguish some informal firms with better management capabilities. Lack of finance in particular means that firms are unable to invest, resulting in lower capital intensity and hence lower labor productivity.
This study examines total factor productivity (TFP) in addition to labor productivity. TFP controls for capital intensity, yet we find the same positive correlation between TFP and formality as we do for labor productivity. This shows that capital intensity alone cannot explain differences in labor productivity and, in turn, provides further evidence that access to credit is not the ultimate source of the productivity gap between formal and informal firms.
We also investigate productivity differentials between large and small informal firms. Our results indicate that large informal firms also have lower productivity than formal firms, but the differential is minor, whereas the productivity gap between large and small informal firms is much greater. Thus, with regard to productivity, large informal firms resemble formal firms much more than their smaller informal counterparts.
The effects of informality on poverty are also important. The literature from various African countries indicates that small informal firms offer returns that can attract workers out of agriculture, but these firms are far more fragile and less likely to grow than formal or large informal firms (Calvès and Schoumaker 2004). They tend to proliferate when economic growth is poor, consistent with the view that such firms are a survival activity of last resort when other employment fails. An implication of this hypothesis is that incomes tend to be much lower in the informal sector than in the formal sector. In chapter 3, we use two measures of poverty—monetary and nonmonetary—and the Living Standards Measurement Survey datasets in the three countries and confirm that poverty is much more prevalent among employees in the informal sector. Overall, the informal sector is a source of income for individuals with limited options, but it cannot be a sustainable source of long-term growth and income generation.
Tax evasion is another well-recognized social cost of informality, and we examine the tax implications of informality on fiscal systems in the three countries. There is a gaping disparity in the respective shares of GDP of the formal and informal sectors and their contributions to fiscal revenue. Indeed, the informal sector provides almost no government revenue, despite accounting for more than half of GDP. We estimate that the loss of fiscal revenue due to tax avoidance of the informal sector amounts to between 3 and 10 percent of GDP. Governments have attempted to impose taxes on small informal firms, mainly through the lump-sum presumptive tax, but outcomes so far have been very disappointing. Large informal firms are capable of paying far more than they do but are able to evade their responsibilities due to underreporting and political clout.
Main Conclusions and Recommendations
Our results confirm the heterogeneity of the informal sector. Specifically, they confirm the importance of the large informal firms in West Africa and the importance of distinguishing the large from the small informal firms in describing behavior and identifying obstacles in the investment climate. While the vast majority of informal firms are very small, large informal firms play a major role in some sectors, notably commerce, and provide important role models, good or bad, for how different governments structure and enforce their regulatory frameworks.
Policy recommendations are likely to differ between large and small informal enterprises. For large informal firms, the goal must be to bring them under the formal regulation net and register them for formal tax regimes. For small informal firms, the policy implications are already quite well known: programs that seek to reduce poverty by improving the capacity of microenterprises, often by supplying training, credit, and business development services, must be instituted or expanded.
The informal sector is in part a symptom of institutional deficiencies, and the large informal sector, in particular, is a symptom of government failure to enforce regulations that should apply to these firms as well as of the burdensome nature of regulations and taxation that inhibits compliance.
For the large informal firms with a genuine choice, policy should be oriented toward a more systematically enforced and enforceable regulatory regime. Governments should systematically test regulations for their social-benefit content and explicitly consider the cost of compliance for firms and the requirements of systematic enforcement for government, along with the cost to credibility of irregular enforcement.
The informal sector is concentrated in nontradable industries, mainly services, commerce, distribution, construction, or locally sourced food products or raw materials. Although the informal sector provides a large share of employment and incomes, these activities lack the growth potential of more globally traded goods.
In order to reach national growth targets, governments cannot rely on the growth of informal businesses, and policy will need to promote the international competitiveness of formal firms, including foreign investors, which have greater potential to boost exports and productivity growth.
The informal sector contributes to an inimical investment climate for formal firms, particularly foreign investors. Thus the dualistic nature of West African economies, characterized by a large unregulated and untaxed informal sector, is an obstacle to sustained growth. The small formal sector—substantially consisting of foreign investment—must shoulder a disproportionate tax burden, severely hampering its competitiveness. These higher taxes and fees lead to further disadvantages for formal firms—and advantages for the informal sector— and reduce foreign direct investment.
It seems impossible for an economy to develop when the bulk of economic activity operates outside of the regulatory and tax regime, so formalization of the informal sector must be a long-term objective.
The informal sector relies on practices that hinder productivity growth. Their lower productivity may be influenced by the fragility noted earlier, lack of transparency or lack of knowledge of their own accounts, long-established traditions based on well-entrenched control of territory and rents, and suboptimal allocation of productive factors (including reliance on family sources for credit). Informality also prevents companies from acquiring modern management skills and worker training, limiting growth potential and access to the world market.
The issue of productivity is also connected to export competitiveness. Given Africa’s small and declining share in global trade, improving competitiveness is a key factor for stimulating growth and raising incomes. Informality makes exporting difficult. Further, survey results indicate that lack of demand is a key constraint facing informal firms. In this context, remaining cut off from world markets through low competitiveness is a devastating obstacle. Finally, the motivation for improving competitiveness and growth may provide a useful entry point for addressing the political economy and governance problems indicated earlier, which have high economywide costs.
Improving the coordination among the diverse registration and tax authorities and the enforcement of a single taxpayer identification system, especially between customs and tax offices, would help to improve the investment climate and address the governance issues giving rise to the large informal sector. However, such reforms will undoubtedly encounter much resistance, given the rents that arise from the current systems.
The informal sector in general—and large informal firms in particular—is responsible for a substantial loss of fiscal revenues and narrowing of the tax base. In addition to numerous difficulties in paying taxes, these informal firms frequently say they do not pay formal taxes because public money is poorly spent.
Business and government should collaborate on an effort to improve both the business environment and tax compliance, in recognition that each side can take actions that will improve the circumstances of the other. Government can and should move independently to improve public expenditure management and promote results-based management. And firms can gain in productivity and access to bank credit if they maintain sincere and transparent accounts and pay formal taxes. However, firms prefer to pay taxes when they know others like themselves will also pay, and the business climate especially needs a systematic enforcement of regulations, which requires public intervention. This mutual interest in reforms should be exploited, and such collaboration is more likely to succeed than a unilateral push for new tax revenues from the informal sector.
The main positive contribution of the small informal sector is that it provides employment and incomes and thereby alleviates poverty. But the incomes in the informal sector are generally low, and low productivity of the small informal sector suggests a limited scope for improvement. Government and donor programs intended to assist small informal firms have had limited effectiveness.
The goal of policies overall is to assist small informal sector firms while inducing them to move toward formal sector status in the long run through a combination of carrots and sticks. However, efforts to promote growth should not focus on small informal enterprises, as their potential is limited. At the same time, enforcement should focus on larger informal firms rather than small firms so as to avoid worsening poverty and unemployment.
In addition to state failures, sociocultural traditions, particularly ethnic and religious trading networks, underpin the informal sector. Understanding the latter may be helpful in fostering the transition toward a stronger formal sector. For example, many people accord far more authority to kinship chiefs than to government. Also, traditional education systems are in some respects far more practical and conducive to building entrepreneurial skills than the Westernstyle schools, which are oriented toward preparing future civil servants. There is much that is positive in the informal sector, and policy can build on this to foster development.
Further research on the sociological basis of economic behavior in West Africa could enhance policies in a wide range of areas, from education to regulation.
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