Johannesburg – The vast underground economy around the world is characterized by below-the-radar flows of money, tax evasion, and poor labor conditions. Less obvious are the sector’s important lessons for self-regulation, new income streams and inclusive financial innovation.
Rather than force food vendors, taxi drivers and small farmers to join the formal economy, new business models are emerging to help informal entrepreneurs self-organize, get loans and improve their supply chains.
In Uganda, for example, Tugende offers informal motorcycle taxis, or “boda bodas,” rent-to-own financing where they would otherwise be unable to access credit or loans. Its risk assessment model is based on local community dynamics and the self-regulating rules of boda boda drivers. (Listen to ImpactAlpha’s podcast: “Financing Uganda’s Boda Bodas to Boost Drivers’ Livelihoods”).
South Africa’s regulation of the taxi industry was similarly informed by self-regulation in the informal taxi sector. In Kenya, Twiga Foods is building a commodity market around informal food networks, which transact 96 percent of food sales in Nairobi.
“Most informal businesses have low productivity and can’t grow. If we force them to graduate [to the formal economy], most will go out of business,” says Soumeya Rachedi, managing director of the Global Entrepreneurship Network in Algeria. Rachedi addressed the topic at the Global Entrepreneurship Congress in Johannesburg, South Africa. “Partial formalization,” of the kind South Africa implemented with its taxi regulation, can also create value for entrepreneurs and the government.
Downside of Formalization
Governments are pushing to graduate the informal businesses into the formal economy. Worldwide, 2.5 billion people earn a living off of subsistence and small-scale farms. In sub-Saharan Africa, the informal sector makes up as much as 41 percent of GDP and 72 percent of total employment. Many businesses are neither taxed nor monitored by the government.
Governments and support organizations should carefully study the informal sectors they are looking to formalize and regulate before enforcing policies.
Aggressive “formalization” can have a particularly negative impact on women entrepreneurs, who generally have fewer opportunities in the formal sector. As businesses shift from the informal economy to the formal, the percentage of women entrepreneurs goes down.
“You don’t want to set women up for failure or create greater barriers to entry,” says Sara Fakir, founder of entrepreneurship support organization IdeiaLab, in Mozambique.
Photo credit: Tugende