Authors: Nathalie Fanelli, Samuel Monteiro
Site of publication: Investisseurs et Partenaires (IETP)
Type of publication: Report
Date of publication: 2019
A better understanding of “Informality”
What do we mean by “informality?”
The lack of a common definition
The first point to note when we examine the concept of informal economy is that there is not an unanimously shared definition on the subject. According to the Organization for Economic Cooperation and Development (OECD), the informal sector includes, for example,“all activities that are not or only partially recorded”.
The International Labor Organization (ILO) defines the informal economy as, “A set of units producing goods or services mainly to create jobs and income for the people concerned. These units, with a low level of organization, operate on a small scale and in a specific way, with little or no division between labor and capital as factors of production. Employment relationships – where they exist – are based primarily on casual employment, kinship or personal and social relationships, rather than contractual agreements with formal guarantees.”
Key concepts
Informality does not equate to illegality. In most cases, the activities of informal enterprises are not criminal or even illegal. They often produce ordinary, legally authorized goods and services. It is rather the way in which they engage in these activities – for example, by evading taxes – that positions them in the informal sector.
Informal does not imply a lack of remuneration. Employment is considered informal when a worker does not have a declared employment contract with the relevant public authorities. That being said, this undeclared work is most often remunerated.
Informality is particularly high in Sub-Saharan Africa, where more than 89% of jobs are informal. This percentage varies greatly from country to country, from 34% in South Africa and 46% in Cape Verde to an overwhelming 95% in Burkina Faso and Benin
The lines between formality and informality are blurry. In many parts of the world, companies are rarely 100% formal or informal. A concrete example: a company can declare part of its income (formality), but not all of it (informality). It can also provide an employment contract to certain employees (formality), while using undeclared subcontractors to increase flexibility (informality). This mixture of formality and informality can take many forms.
The most predominantly informal companies are not always the smallest . While larger and more mature companies are generally more (often) formal than small companies, firms that do tens of millions of euros in annual turnover can also be predominantly informal. This is particularly the case in the Sahel countries.
Where are we now
Due to its very nature, reliable data on the informal sector is difficult to collect. However, some estimates by recognized international organizations reveal how widespread the phenomenon is, particularly in Africa.
Worldwide
According to the latest ILO report (2018)¹, more than 60% of the world’s population works in the informal sector. These 2 billion men and women are very often deprived of decent working conditions.
In Africa
Informality is particularly high in Sub-Saharan Africa, where more than 89% of jobs are informal. This percentage varies greatly from country to country, from 34% in South Africa and 46% in Cape Verde to an overwhelming 95% in Burkina Faso and Benin.
Formalization: a relatively recent process in developed countries
It should not be forgotten that informality was still very common in developed countries such as France in the 1960s and 1970s. “At the time, there were many “grey areas” in companies, even the largest ones,” explains I&P advisor Bruno Caire. “There were no precise or standard quality metrics, for example. The accounting of small businesses was most often done manually.”
Did the rapid development and implementation of IT throughout French companies force the retreat of this long-standing informality? “IT certainly plays a role as an accelerator in the formalization process, but it is far from responsible for this shift. Indeed, to computerize a company, there must already be precise, reliable and functional formal processes in place” says Bruno Caire.
Nevertheless, the development of digital tools in Africa is undeniably opening up new perspectives in favor of greater formality. The increasing percentage of mobile payment systems (with improved traceability), the digitization of certain business registration formalities, the increasing possibility to pay taxes online, etc.–these developments are contributing to this dynamic today.
Informality on the Company Side
Complex and interrelated issues Why would an entrepreneur choose to operate in the informal sector? By choosing to place all or part of their venture in the informal sector, an entrepreneur may believe they are taking a rational decision. They generally put forward five general arguments to explain this decision.
Avoiding Public Authorities
▪ The informal sector is often perceived as a refuge from administrative constraints: taxes, regulations, administrative documents, etc.
▪ Informal entrepreneurs seek to avoid excessive bureaucracy and fiscal harassment by public authorities
Greater Flexibility
▪ In the absence of regulations, informality allows for greater flexibility in hiring and work organization.
▪ Informality makes it easier and quicker to adapt to economic fluctuations.
Family Management
▪ Often, the children of informal entrepreneurs inherit the social capital and the networks of their parents, which in turn encourages them to operate in the informal sector.
▪ The family management of a company inherently favors informal development.
Advantages of formalization
The entrepreneur may have the impression of making a beneficial choice by operating in the informal sector, but to what extent is this true? It appears that a company can derive many advantages from formalizing its business activities, particularly in the long term. Better performances on average, declared companies increase their profits by 20% and gain more opportunities to advertise.
Easier access to credit
In Dakar, the average interest rate for formal firms is 15.3%, compared to 20.7% for informal ones.
Better connection to public infrastructure networks
In Dakar, 80% of formal companies are connected to the water distribution network, compared to 55% of informal companies.
Disadvantages of formalization
Formalization is a complex process that can be difficult to implement and, in some cases, even a double-edged sword. The disadvantages are just as real as the advantages, especially in certain sectors:
Binding Procedures
The formalization process has disincentivizing monetary, temporal and operational costs, especially due to administrative procedures.
Lack of Flexibility
The informal sector allows companies to react more nimbly to economic fluctuations and easily adapt the number of workers. This level of flexibility is sacrificed with formalization.
Recommendations
Integrate the company’s formalization process in your business plan. It is essential to plan for the formalization process upstream and integrate it into your business plan from the outset, in order to ensure that your company’s sales prices and margins can bear the additional cost of the new taxes.
Do not underestimate the cultural change. Formalization does not only constitute a legal or fiscal process or one tied to social obligations. For instance, once employment contracts are in order, a company must develop a salary scale and a remuneration policy, write job descriptions, conduct individual interviews with employees, consider a possible training policy, etc
Integrate the company’s formalization process in your business plan. It is essential to plan for the formalization process upstream and integrate it into your business plan from the outset, in order to ensure that your company’s sales prices and margins can bear the additional cost of the new taxes
Formalizing, therefore, means working differently. This significant cultural change can lead some employees to feel overwhelmed, isolated or even to leave the company. It is essential to pay attention to and prepare for these changes by putting concrete actions in place to help employees manage the transition.
Informality on the Employee Side
Informality: what are the consequences for employees?
Informal employees most often have insufficient income and precarious living conditions. This precariousness can affect a worker’s productivity and employability, as well as their health, resulting in a vicious circle of informality and poverty.
Poverty
Informal employees face significant poverty that sustains itself. In Senegal, for example, 41% of informal workers are paid less than the legal minimum wage, while they are only 2% of formal employees. Access to electricity is also much lower for informal workers, resulting in radically different living standards.
Vulnerability
Income disparity between workers is higher in the informal sector, especially since wages are less stable because due to overreactions to fluctuations in the economy: incomes fall more sharply during a crisis. Informality and vulnerability, thus, go hand in hand.
Human Capital
The stress related to the fear of the future is detrimental to the health and professional development of informal workers, which in turn affects their productivity. The lack of training makes workers’ skills obsolete and unsuitable for market requirements, further reducing their employability.
Recommendations
Explain and raise awareness. Formal employment and contracts are not always fully valued because employees are simply not aware of the benefits. For example, some people are not aware that health insurance is linked to their employment. Likewise, many do not know that they are contributing part of their salary to retirement. Most employees therefore count only their net salary i.e., the money they have at their disposal, as remuneration. Explaining the various contributions and benefits provided by an employment contract is an important element in building company loyalty.
Invest in employees via permanent contracts. Workers overwhelmingly associate the positive impacts of an employment contract with a permanent contract (as opposed to a short-term one). The stability linked to a permanent contract provides employees increased access to credit and to the pursuit of personal projects. and also promotes employee development, productivity and loyalty. Therefore, offering this form of contractualization is encouraged and can be viewed as a beneficial investment in the company’s success.
Explain and raise awareness. Formal employment and contracts are not always fully valued because employees are simply not aware of the benefits. For example, some people are not aware that health insurance is linked to their employment
Improve health coverage linked to an employment contract. In practice, only 40% of health expenses are covered, while the coverage rates posted often vary around 80%. Many drugs are not covered. This lack of coverage generates dissatisfaction among employees, for whom health insurance is essential.
Compensate for overtime. Even when an employee has an employment contract, the legal work limits are often not respected and overtime hours are required. However, this overtime is generally not remunerated. Measures to compensate for these many unpaid and unrecovered overtime hours would strongly enhance the value of the employment contract in the eyes of employees.
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