Formalising informal enterprises without damaging job opportunities

The number of people seeking jobs is growing faster than the number of jobs created in the formal economies of many developing countries. Informal enterprises, mostly micro and small enterprises that avoid compliance with government regulations, often become the main employers. In Tanzania, competition for jobs in the informal sector is very high as it attracts the unemployed, graduates and poor people. Should government enforce formalisation?

In Tanzania, the informal sector is growing. Although the quality of jobs created is low, and there is little compliance with employment, consumer or environmental regulation, the government is tolerant because it helps poverty alleviation. However, failure to comply with regulations restricts the quality of Tanzania’s economic development. International institutions and donors urge the government to formalise informal enterprises, but the operating costs in the formal sector would be higher and enforced formalisation risks putting many people out of business. The large size of the unregulated sector restricts the efforts of international institutions and donors to contribute adequate aid.

Enterprises formalise voluntarily if and when the benefits outweigh the costs, suggesting that, as an alternative to enforced formalisation, governments should consider a policy to encourage and facilitate voluntary formalisation. This would require the government to offer a low-cost, affordable and regulated environment to low-performing small-scale enterprises. However, the Tanzanian government makes no official distinction between enterprises that can afford the current high-cost environment and those that cannot.

A study from Durham Business School in the UK and the University of Twente in the Netherlands assesses the factors that would help informal enterprises to move into the regulated sector.

The report finds that:

• The decision to formalise rests on three considerations: the value of legitimacy, rights and legal status; the loss of potential gains when deciding not to formalise; and the costs of moving into the formal sector.
• Negative factors outweigh positive ones: in particular, high costs mean that many enterprises have no present alternative but to remain informal.
• Administrative and regulatory cultures designed for larger government enterprises generally obstruct small-scale businesses from entering the formal sector.
• Rules or terms agreed between the government and informal sector would be more enforceable than terms imposed by governments acting unilaterally.

The informal sector survives by offering opportunities to poor people and by offering a low-cost environment for new ventures to operate. Government initiatives should support these factors as it encourages business to move into the formal sector. The authors suggest a number of policy implications:

• The government should recognise, build the capacity of, and work through representatives of the informal sector to develop relationships with informal operators.
• Formalisation should be seen as an exchange transaction between government and enterprises based on agreed terms.
• Agreed terms should be negotiated between small-scale sector associations and governments.
• Governments must address and reform a number of factors, including: the system of legislation and regulations, an administrative culture that does not understand the small-scale sector enough and the lack of private sector competency in participating in dialogue with government.
• Entry costs into the formal sector should be at a level that encourages informal operators to move into the formal sector rather than turn them away.

Source(s):
‘The Voluntary Formalisation of Enterprises in a Developing Economy – the Case of Tanzania’, Journal of International Development, Volume 17, Issue 4: 575-593, by Edwin Nelson and Erik de Bruijn, 2005

Funded by: NUFFIC - Netherlands Organisation for Cooperation in Higher Education

id21 Research Highlight: 16 September 2005

Further Information:
Edwin Nelson
Associate of Durham Business School
Mill Hill Lane
Durham DH1 2PQ, UK

Tel: +44(0)191 334 5200
Fax: +44(0)191 334 5201
Contact the contributor: nelson20202@yahoo.co.uk

Durham Business School, UK

Other related links:
'Vocational educational and training institutes in Nigeria: unable to meet the needs of employers?'

'Informalisation of labour in South Africa’s fruit export industry'

'Business development support to small service providers'

'Unemployment in South Africa: self employment the solution?'

'Supporting Workers in the Informal Economy: A Policy Framework, ILO working paper'