Localising development ­— V

Mahmoud Mohieldin
Tuesday 10 Oct 2023

Should the informal economy in the developing countries be left to its own devices or should it be integrated into the formal economy to reflect its role in the GDP, increase tax revenues and social security coverage, asks Mahmoud Mohieldin



he informal sector of the economy is the object of growing attention among decision-makers and those concerned with development in the developing nations.

There are numerous and conflicting views on this sector. Some argue that it should continue as a safety valve that both supports the economy and mitigates unemployment. Others say it should be contained and assimilated into the formal economy, thereby contributing to state revenues and enabling the GDP figures to reflect all the economic activities in the country in question.

A recent World Bank study on informality and inclusive growth and focusing on North Africa examined how official policies, organisations, and laws affect decisions regarding entrepreneurship, production, investment, financing, and employment in the informal versus the formal sectors of the economy.

According to the study, one of the results of statistical surveys of the labour markets in Tunisia, Egypt, and Morocco is that informal employment in Tunisia, Egypt, and Morocco has risen to 44, 63, and 77 per cent, respectively. The study identifies three areas for policy reform and coordination.

The first is entrepreneur-worker relations and covers institutions and laws such as social and health insurance programmes, labour regulations and the minimum wage, and the efficacy of regulatory and enforcement systems.

The second is taxes and transfers and encompasses the laws that regulate taxation on income, profits, consumption and sales, and the structure and efficacy of the agencies in charge of collecting taxes and enforcing the tax laws.

The third is market conditions and includes systems for ensuring contracts are upheld, the efficiency of credit and financing institutions, the relative ease and costs of the registration and licensing processes for business premises, and the laws that regulate fair competition and prevent monopolies.

The report identifies proposals for comprehensive and integrated public policies designed to provide appropriate protection against risks, whereby risks common to all citizens would be funded from general taxation, risks common to all workers would be funded from workers’ earnings, and risks specific to workers employed in firms would be funded from firms’ contributions and proportional to workers’ wages.

It also underscores the importance of providing social security protections to the poor in accordance with recognised standards for dealing with economic fluctuations and shocks. Such measures necessitate restructuring tax policies and institutions and readjustments to social security systems to encourage employment in the formal sector.

Alongside such policies, the study urges the development of better conditions for doing business, whether by facilitating processes through digitisation or by improving regulatory systems to ensure good governance and fair competition.

In the course of discussions I had with Gladys Lopez-Acevedo and Nistha Sinha, two of the report’s authors, along with Nadir Mohamed, regional director of the Middle East and North Africa (MENA) region at the World Bank, and Karim Al-Aynaoui, executive president of the Policy Centre for the New South, I raised various points, including those summarised below.

My first point was that developments in the informal economy in the developing nations should not be viewed in isolation from the performance of these countries’ economies in general. This is all the more the case given that they have sustained various economic shocks, disruptions, and some poor crisis management, all of which have combined to reduce their ability to achieve the UN Sustainable Development Goals (SDGs) by the target date of 2030. This is especially true of the goals having to do with extreme poverty, unemployment, and equitable income and wealth distribution.

Moreover, these countries have seen a decline in human development indicators, a reduction in real growth in per capita incomes, rising inflation rates, and lower productivity.

My second point was that rapid rural-to-urban migration in the developing countries challenges traditional assumptions about the role of extended families as support networks, especially in times of hardship and need. It also alters the structure and nature of the informal labour market, including women’s participation.

My third point was that we have yet to fully understand the initial impacts of digitisation and artificial intelligence (AI) on the formal labour market, let alone the parallel and informal labour markets, seasonal and irregular labour, and the phenomenon of nomadic labour in the digital age.

My last point was that the informal sector, in a departure from its customary behaviour in previous crises with fluctuating business cycles, has not shown a capacity for absorbing the adverse effects of the Covid-19 pandemic.

According to a recent study of informality and business cycles (“Informality, Labor Market Dynamics, and Business Cycles in North Africa”) by International Monetary Fund (IMF) staff Olivier Bizimana and Shant Arzoumanian, informal employment declined sharply during the pandemic in 2020. This means that the informal labour market did not perform its usual, and assumed function, as a safety net by absorbing laid-off workers from the formal sector.

The huge UN project that is being carried out to review GDP as an economic and development indicator will affect how some informal economic activities and women’s economic participation and some other important considerations are factored in when measuring a country’s economic performance.  

GDP has certain relative advantages in terms of the purposes for which it was designed, but it has limitations in terms of other aspects for which it was not designed. To comprehend the extent of progress, or lack thereof, in attaining the SDGs, including those related to social capital, environmental change, natural capital, and the determinants of inclusive growth, there must be a review of the methodology used in calculating this indicator.

In addition, it must be used together with other vital indicators that policymakers can also consult, much like a driver relies on a dashboard of instruments, and not just one, when driving a motor vehicle. Those indicators should also be readily accessible to the public at large, so that people in general can monitor the state of the economy and the development process.

Countries that first forged the path of economic progress can offer a lesson on how to deal with the informal sector and whether it should be left to economic and social developments to sort it out over time, or whether governments should act on their instincts to hem it in and incorporate it into the formal sector.

Some of the most advanced economies in the world today that celebrates its formalised and systematised economic life were once a hotbed of economic informality. The situation in this country only changed to become what we see there today when its formal sector became truly formal in terms of efficiency, low procedural costs, and the advantages of being part of the formal economy.

What have historically driven many people to informal alternatives in the labour markets and the business and credit systems are the many deficiencies in what is generously called the formal sector in many of the world’s developing countries.


This article appeared in Arabic in Wednesday’s edition of Asharq Al-Awsat.

* A version of this article appears in print in the 12 October, 2023 edition of Al-Ahram Weekly

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