Supporting the Policy Environment for Economic Development

Informal Sector Study

This report presents an empirical analysis of informality in Mozambique with a view to informing policy discussion on this important aspect of the economy. The analysis employs the most recently available government data to examine the characteristics of a sample of informal economic operators, highlight the differences between different types of informal firms, and estimate performance differences within the informal sector which relate to micro-firm business registration. It also discusses informality in the context of a trade-off of costs and benefits to formality at the enterprise level, and the potential impact of current policy measures on that balance. This has implications for the PARPA II goal of increasing formalization, suggesting the need to encourage enterprise expansion and investment through a focus on increasing the benefits to formality in addition to reducing the costs, while putting less emphasis on attempts to raise tax revenues from these micro firms.

Doubts are frequently raised about the impact on employment and incomes of recent impressive economic growth rates in Mozambique. These are generally attributed to large capital intensive “mega-projects”, a post-conflict growth rebound and large flows of foreign aid, with the implication that growth has benefited only a small share of the population. Job creation is thought to be weak, a low share of employment is in manufacturing where there is more value added, and an increasing share of output is from the service sector, much of which is informal. Policy discussion has therefore increasingly centered on private sector development: the policies required to encourage investment, enhance productivity growth, increase exports and ultimately stimulate employment and incomes. A major factor is the business environment, with an important consequence of a poor business environment and burdensome business regulations being a large informal sector.

Although informal activity is difficult to measure, the INFOR survey on which this analysis is based suggests that 75 percent of the economically active population is employed informally in Mozambique (INE, 2006). Ministry of Planning and Development (MPD) estimates using national accounts data suggest that informal activity represented 41 percent of GDP in 2003 and 40 percent in 2004, (MPD, 2009). This is in line with other estimates which put informal activity at 42.4 percent of GDP in 2002/03. Further, Mozambican enterprise census data reveals that the median firm in Mozambique has only two workers, while 78.1 percent of firms have up to only five workers (GoM, 2004a). Many of these firms are likely to be informal at least to some degree. Informality on such a scale demands attention in economic policy design.

The policy relevance is further underlined by recent World Bank enterprise survey evidence which

including access to finance, taxes, and other common complaints in the private sector (World Bank, 2009). While this could reflect improvements in other areas of government policy, and may also refer to the informal practices of formal firms, it nonetheless highlights the importance of an improved understanding of the informal sector and its characteristics.6

Improving the business climate to increase formalization is one of the principal challenges presented in the government’s second Action Plan to Reduce Absolute Poverty (PARPA II), under the economic pillar. However, despite increasing attention, there are few in-depth analyses of informality in Mozambique. Further, despite the stated government desire to formalize the private sector, the steps required are not clear. Although policies to improve firm-level efficiency, promote productivity growth and integrate the national economy are important it is also important to recognize the heterogeneity of informal firms and the mechanisms through which policy might impact the firm decision on whether or not to operate informally.

Further, it is important to understand why greater formalization might be desirable. While the government tends to focus on raising revenues, where micro informal firms are concerned, the benefit from formalization is more likely to be the secondary effects of allowing enterprises to operate legitimately, and thus potentially raising their productivity and ability to integrate more deeply with the national economy.

But as is now widely understood, informal activity plays at least two distinct roles in a developing economy: i) providing a source of survival income to low-income and frequently unskilled individuals, and ii) representing an active and potentially competitive component of the productive sector. This requires a balance of the potential for greater employment and productivity growth of the more productive firms with reducing the vulnerability of those working informally out of necessity.

Among more competitive firms it is particularly important to examine the enterprise-level trade-off of the costs and benefits of informality. If informal enterprises are small and reluctant to expand due to bureaucratic barriers or the need to escape the attention of corrupt officials, this might be altered by reducing the costs and increasing the benefits of operating a small, formal business. However, even if the legal costs of operating formally are reduced, what about unofficial costs, and what are the actual benefits to operating formally? Raising the benefits in relation to the official and unofficial costs of formality will encourage greater formality, thus permitting greater firm expansion and employment growth. The aim should be to achieve enterprise growth with assistance from, and not in spite of, government policy.

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