Home » Business » Strengthening Formal, Informal Sector Linkages [opinion]

Literature on the development of the informal sector notes that a key strategy for the promotion of the sector should be the strengthening of its linkages with the formal sector.

It further asserts that a supportive policy and institutional framework for the formal sector is likely to result in the growth in size of the formal sector, expansion of its market boundaries, and facilitate the transfer of modern technology and managerial expertise to the informal sector.

The most controversial issue in the debate on the linkages between the two is on how the informal economy and formal economy are linked.

However, these debates have tended to blur the distinction between the formal economy, the formal regulatory environment and their inter-relationship with the informal enterprises.

This requires creating a difficult distinction between what is really identified as the informal sector and the traditional formal sector, being a very grey area.

For example, if we look at the bulk of businesses selling spare parts for vehicles or clothing and other items in down town Harare’s Kaguvi, Chinhoyi and Mbuya Nehanda streets, can these be classified as formal or informal businesses?

Yes they pay rents, rates and license fees to Harare City Council but most do not operate bank accounts or pay most of the other taxes such as NSSA and corporate tax. The majority may not be registered for Value Added Tax and Pay as you Earn. They pay some taxes some are sole-traderships while some are registered companies.

Looking at this practical example makes one realise just how difficult it is to clearly define a formal business from an informal one. Few informal enterprises, except perhaps some survival activities, operate in total isolation from formal enterprises.

Most source raw materials from andor supply finished goods to formal firms either directly or through intermediate (often informal) firms.

Sourcing and supplying of goods or services can take place through individual transactions but are more likely to take place through a sub-sector network of commercial relationships or a value chain of sub-contracted relationships.

To understand the linkage between informal and formal enterprises, it is important to consider the nature of the production system through which they are linked.

This is because the nature of the linkage specifically, the allocation of authority and economic risk between the informal and formal firm, varies according to the nature of the production system.

For instance, a garment maker might produce for the open market with some authority and all of the risk. It might also produce for a supply firm linked to a multinational firm with little authority but much of the risk in the form of non-wage costs, rejected goods, and delayed payments.

Given that the informal economy is here to stay and that the informal and formal economies are intrinsically linked, what is needed is an appropriate policy response that promotes more equitable linkages between the informal and formal economies and that balances the relative costs and benefits of working formally and informally.

This linkage is very important for the financial services sector as it gives the sector an opportunity to use the linkage to the best aantage of the informal sector.

Banks would be keen to deal with those informal sectors that have a clear understanding of how they are linked to the formal sector players.

Understanding the linkages is also important because the amount of financial sector support available to informal sector players is far less than ideal but has the potential to increase if the opportunities brought about by the linkages are fully exploited.

This can be further tightened through formation of organised structures in the informal structure because these are easy to deal with. Other challenges currently faced by the informal sector players can also be easily resolved through g linkages between the formal and the informal sector.

Despite SMEs’ g interest in credit, banks’ profit orientation may deter them from supplying credit to them because of the high transaction costs and risks involved but with linkages to the formal sector this can easily be resolved because the source of the problem can be watered down due to the links between the informal and the formal structures.

First, SMEs’ loan requirements are small, so the costs of processing the loans tend to be high relative to the loan amounts.

Second, it is difficult for financial institutions to obtain the information necessary to fully assess the risks of new, unproven ventures, especially because the success of small firms often depends heavily on the abilities of the entrepreneur.

Third, the probability of failure for new small ventures is considered to be high. These challenges can be easily be surpassed if formal sector players are willing and able to support the sector.

Through financing the value chain or the big end user of the product, the banks will be indirectly financing the informal sector player producing intermediate inputs to the formal final producer.

This can be illustrated through the following on the producer market the modern informal and formal sectors are complementary, as modern informal intermediates may be used in formal sector production.

Some informal firms may also undertake part of the production process of formal firms through subcontracting. As long as the formal sector grows, and especially if it is competitive, then the informal sector will grow as well.

Its growth also depends on the resources available, and Government policies that affect the relative prices of modern informal and formal goods.

This scenario shows that banks can be able to lend to the informal sector and expect to recoup the loans through the transaction directly from the informal sector or indirectly from the formal organisation.

Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe.

Source : The Herald