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Document Abstract
Published: 2016

Sticks rather than carrots to induce more formality

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Formalization has many potential benefits for the government, firms, workers, the economy and society. Decisions by firms to move into the formal economy depend on their cost/benefit calculations. Using legal enforcement, inspections and fines may be more effective at getting firms and workers to move into the formal economy than making it easier and cheaper to register; but they are not mutually exclusive, and policymakers should use an integrated approach. Policymakers should follow development policies such as upgrading skills, encouraging microfinance and reform of social security coverage to encourage formalization.

Summary: 

  • formalizing informal firms and employment has a number of potential benefits for the government, firms, workers, the economy and society.
  • these include: increased tax revenue; more efficient reallocation of resources; increased output and income for firms and the economy; decent working conditions for workers; orderly work and business environments; and improved morality for society
  • reforms to encourage firms to register and formalize can come in the form of both inducements such as better information and lower costs (carrots) and legal enforcement (sticks)
  • research shows that better enforcement policies, inspection and fines may have a larger impact than reducing the costs of registration, simplifying the rules and regulations and disseminating information on registration procedures. However, the two are not mutually exclusive
  • policymakers should use an integrated strategy to bring informal workers and entrepreneurs into formal channels of protection, support and responsibilities with registration, while preserving their resilience and dynamic potentials
  • wider development and growth policies are important to help firms and workers move into the formal economy. They should also include skills training programs for upgrading skills of workers and entrepreneurs, microfinance and reforms for extension of social security coverage. 
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Authors

A. Tansel

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