Africa: Should “Formalization” Be Part of the Post-Covid Economic Agenda?

As African economies continue to stagnate in the wake of Covid-19, policymakers are scrambling to put in place plans for economic recovery. Reading about these recovery plans (such as here, here, and here), I’ve been struck that formalization is again on the agenda of policymakers ravenous for revenues to boost recovery budgets.

This formalization agenda has a modern twist, with some governments viewing the “digital economy” as a priority arena to both boost business activity and to tax. A number of these digital economy firms are platforms, like ride hailing companies, where individual workers are newly visible to the state, because their work is mediated by digital technology. In other words, they, in part, tackle the “formalization” agenda.

Now well into a PhD dissertation on platforms in Kenya, I am not very optimistic that such services will lead to the kind of economic advancement and transformation policymakers intend. Platforms can and often do create marginally better work opportunities for atomized, informal workers. What they do not and cannot do is to fix more endemic productivity challenges. We need many and diverse firms to do that.

“Informality,” though often used as a pejorative and treated as something that market-oriented policymakers ought to eradicate, is the outcome of systemic dysfunction and trade realities. It is the result of weak market governance, not the cause. That informal self-employment is so much more desirable than formal work in Kenya today–a robust finding of my 10 years of research in the country–ought to cause alarm. Without firms–firms where Kenyans want to work–the country’s long-term future is bleak. Kenya will be a country that stays in a productivity trap, one that wastes its human capital, that cannot innovate, and where the gaps between the owners of productive firms and everyone else widens every year.

Since its emergence in the early 1970s, informality has become the shorthand we use to label what James Ferguson called the abundant “improvised” livelihoods in Africa. But definitions of informality pool several incongruous attributes. The 1993 International Conference of Labour Statisticians (ICLS) defined the informal sector as “production and employment that takes place in unincorporated small or unregistered enterprises.” This definition was updated in 2003 to also include “informal employment” covering employment without legal and social protection. Informality has also been used to refer to enterprises without government regulation, and some simply use firm size as a proxy for informality, considering any self-employment activities “informal.” The reality, however, is that firm size, regulatory status, and employment protections are three distinct features. If we worry that informality is “bad,” what exactly are we protesting? What actually matters to workers and economies?

Those concerned mostly with worker welfare worry that informality leads to unreliable wages and no benefits like paid leave and health insurance. Such workers are “precarious” and in need of protection. However, where formal work is rare–and itself quite precarious–many have raised questions about whether such protections ought to be delivered by employers or directly by the state to all members of society. In reality, the demand for such protections from workers themselves varies, with some workers feeling that the state and employer take more than they give back when it comes to benefits. My own respondents told me that they felt workplace benefits like government healthcare and pensions were “a scam.” Employers not infrequently deducted payroll taxes without ever submitting the funds to the tax authority, causing endless headaches for workers. It has become notoriously difficult to ever reclaim pension savings collected by the state through payroll deductions.

From an economic perspective, Hernando de Soto (2003) famously argued that the lack of government registration was holding back the productivity of informal workers who could not collateralize their assets. The natural policy response was to register them and make registration easy. In practice, registration alone failed to unleash new productivity. Still, governments have tended to be very excited by this idea. When firms are visible to the state, they are, in theory, taxable. However in places like Kenya, so called “informal” firms actually are registered in dozens of ways through many different government agencies. Such permitting requirements amount to revenue generation via fees (if not income taxes, which are very difficult to document without advanced bookkeeping) and private extortion from civil service agents sent out to enforce these many varied permitting requirements. Through both “small taxes” (like burdensome licensing) and their relatively low ability to account for expenditures, small firms often already bear a disproportionate burden of taxation in Africa, as demonstrated by Moore, Pritchard and Fjeldstad in their recent book, Taxing Africa.

Where we should actually be concerned is with the productivity of informal firms, and in particular, through self-employment. The atomization of the workforce–the absence of the technology of a firm–prevents the productivity gains that come from specializations in functions, economies of scale, and much greater market access.

My previous research in Kenya shows that micro-enterprises are most constrained by the small scale of the markets they serve and their lack of a management and market apparatus. I found, for example, that small retail operations with growth potential were often slowed by an inability to manage employees, ensuring they put forth strong effort in the absence of the owner and also did not drain the business through theft. Looking at even smaller businesses through a household lens, I found that such enterprises passed through (or failed to pass through) a series of growth bottlenecks that alternated between capital constraints preventing new investments in equipment or stock and, often more importantly, the limits of local market size that prevented them from selling more products in the areas where they lived. Growth would require either relocating to a busier area or opening a new branch, both options coming at a high cost and the option of new branches simultaneously creating the new challenge of remotely managing personnel.

The more sophisticated entrepreneurs I study now are limited by rather constant government harassment and extortion, perpetual inept management of the port, cyclical demand contractions around potentially violent elections, and whimsical policymaking and regulatory enforcement. Government has made growth too risky and too costly. Entrepreneurs choose to stay small, and that is crippling the country’s capacity to ensure that productivity advances and that many Kenyans share in those gains.

Platforms, like Uber, Safeboda, and Jumia, can help address the productivity challenges of informal entrepreneurs by providing the technology of a firm to better manage production. Those who participate access a larger local and more distant markets. That is good news for the many Kenyans who can ride a motorbike or drive a taxi for a living. But platforms remain small and focused on a limited set of specialized, direct-to-consumer services.