Nigeria’s Shadow Economy

Organising the informal sector and harnessing its massive potential will significantly enhance government’s non-oil revenue drive, writes Obinna Chima

With the rising level of unemployment in the formal sector, the number of those seeking for opportunities in the informal sector has continued to swell.

In its latest report, the National Bureau of Statistics (NBS) revealed that the country’s unemployment rate rose from 14.2 per cent to 18.8 per cent in 2017. According to the NBS, the total number of people in full-time employment (at least 40 hours a week) declined from 52.7 million in the second quarter 2017 to 51.1 million in third quarters.

It also stated that the unemployment rate increased from 14.2 per cent in the fourth quarter 2016 to 16.2 per cent in second quarter 2017 and 18.8 per cent in the third quarter, 2017.

This increases the number of those in the informal sector. The sector, which is also referred to as ‘grey economy’ is the part of an economy that is neither taxed, nor monitored by any form of government.

Unlike the formal economy, activities of the informal economy are not included in the gross national product (GNP) and GDP of a country.

In fact, the International Monetary Fund (IMF) recently pointed out that unregistered household enterprises comprise a significant portion of Nigeria’s economy, accounting for as high as 65 per cent of the country’s Gross Domestic Product (GDP).

The fund noted that by 2035, sub-Saharan Africa will have more working-age people than the rest of the world’s regions combined with pressure on governments to provide jobs for them.

According to the IMF, in sub-Saharan African, up to 90 per cent of jobs outside agriculture are in the informal sector, including household enterprises that are not formally registered, like street vendors or domestic workers as well as off-the-book activities by registered firms—for example, the taxi driver that offers a discount if the meter is not turned on.

“The informal economy in sub-Saharan Africa is the second-largest in the world, after Latin America and the Caribbean. From 2010 to 2014, sub-Saharan Africa’s informal economy accounted for 38 percent of GDP to the region,” the IMF said.

“Household survey data suggest that people working in the informal sector consume more goods and services than those in the agricultural sector in many countries,” the fund stated.

Indeed, the informal sector generally is characterised by absence of official protection and recognition, non-coverage by minimum wage legislation and social security system, predominance of own-account and self-employment work, absence of trade union organisation, low income and wages, little job security as well as the absence of fringe benefits from institutional sources.

The informal sector represents an important part of the economy, and particularly of the labour market, in many countries, especially developing countries, and plays a major role in employment creation, production and income generation.

Clearly, in countries with high rates of population growth such as Nigeria, the informal sector tends to absorb most of the growing labour force in the urban areas. Informal sector employment is a necessary survival strategy in countries that lack social safety nets such as unemployment insurance, or where wages and pensions are too low to cover the cost of living.

According to the Africa Development Bank (AfDB), the prominence of the informal sector stems from the opportunities it offers to the most vulnerable populations such as the poorest, women and youth.

Even though the informal sector is an opportunity for generating reasonable incomes for many people, most informal workers are without secure income, employments benefits and social protection, the multilateral institution noted.

This explains why informality often overlaps with poverty. For instance, in countries where informality is decreasing, the number of working poor is also decreasing and vice versa.

Beyond poverty and social issues, the prevalence of informal activities is closely related to an environment characterised by weaknesses in three institutional areas, namely - taxation, regulation and private property rights.

Higher taxes and complicated fiscal process may prevent informal sector operators from formalising their activities. Long requirements for registration as well as licensing and inspection requirements are also barriers faced by the informal sector.

Moreover, limited access to capital is an important constraint for operators working in the informal sector. Lack of skills, education and training are also impediments to the formal sector in Africa. Other factors include the limited access to technology and poor infrastructure. Furthermore, the informal sector doesn’t seem to be on the development agenda of African countries or their multilateral development partners.

Link between the Formal and Informal Economies

A report by Phillips Consulting stated that the relationship between the formal and informal economies has generally been regarded from two opposing viewpoints: dualism and structuralism.

It explained that the dualists believe that both economies operate independently of each other and have very few linkages, with the informal economy being the ‘lesser’ of the two. On the other hand, structuralists regard the two economies as being fundamentally linked.

“Indeed, the formal and informal economies are linked, with the informal economy often trading with, and providing goods and services for the formal sector. In fact, many formal establishments hire employees under informal circumstances.

“For example, large manufacturing firms may subcontract certain parts of a manufacturing process to outside hires, some of whom may be located in other countries. These sub-contractors, although working for a formal organisation, may be operating in the informal economy, due to the fact that these workers may not be afforded the employment benefits that formal employees enjoy.

“In some cases, this informal connection may even be illegal. This is evidenced by the use of sweatshops by some large corporate organisations, where employees are made to work in socially unacceptable conditions for long hours, and provided with salaries below the minimum wage,” it added.

However, the report noted that the informal economy is poorly regulated and so workers are often able to increase their take-home earnings by avoiding taxation and social contributions.

It is also common for entrepreneurs in the sector to seek to reduce costs associated with wages and social benefits.

Due to the non-payment of taxes by some of these enterprises, there are fewer funds available for the government to improve infrastructure, and provide other public goods and services in the sector.

Harnessing Opportunities

A former Deputy Governor of the Central Bank of Nigeria, Prof. Kingsley Moghalu argued that formalising the informal sector would help accelerate revenue from taxation in the country.

He explained: “If you look at Nigeria today, you find that the penetration of mobile telephones is very high, about 140 million lines out of 180 million people. You also find that the informal economy is huge in Nigeria – 65 per cent of our GDP according to the IMF.

“But, what is the effort that is being made to bring the informal economy into the formal economy? It is when you bring the informal economy into the formal economy that you can generate massive amounts of tax revenue.

“Now, how do you bring the informal economy into the formal economy? The path to achieving that runs through the mobile telephone. If the government were to follow mobile telephone ownership in Nigeria, they would get to nearly every Nigerian.

“If you get to every Nigerian whose simcard is registered, then you do a tax audit of that individual. If you are not paying tax, why not? What is the arrangement that can be set up now so you can pay taxes? Even if you are a street hawker and you have a mobile phone that is registered, why would you not pay tax to the state?

Also, the President, Chartered Institute of Bankers of Nigeria (CIBN), Prof. Segun Ajibola, said formalising the informal sector would help promote financial inclusion, allow for effective transmission of monetary policy as well as boost government’s revenue generation capacity.

“The financial inclusion programme is to make operators in the informal sector to be able to access the financial system and also enables them to be able to access some of the intervention funds in the country.

“The reason why microfinance banks were set up was to help those who are in the informal sector to also have access to funding and necessary support to operate. You know there rules and regulations in this country that also encourage co-operatives society. If properly structured, those in the informal sector can take advantage of the opportunities to access certain facilities.

“We also need to still study the kind of models they have in countries such as Malaysia, Singapore, Indonesia, South Korea and even India, where operators in the informal sector are contributing significantly to the GDP of their nations. So, we need to study how they have operated their models successfully to make impact in their economies,” the CIBN president added.

But the Chief Executive Officer of Proshare Nigeria Limited, Mr. Femi Awoyemi, held the belief that over 75 per cent of Nigeria’s population operate in the informal sector.

According to him, corruption has also been a major source of funding for the informal sector.

Awoyemi said: “Whenever we draw our budget and we don’t take that sector into consideration, then we are missing the point. Formalising the informal sector is not just what government needs to do, it is the only thing they need to do because that is almost the whole economy of Nigeria we are talking about.”

Therefore, the formalisation process for informal sector operators should be a key area for consideration for governments at all level.

In fact, many informal sector operators are afraid of formalising their businesses because of the perception that it comes with additional cost and obligation. This, therefore requires proper enlightenment from the government as to the benefits these set of operators stand to benefit. Thus, policies to reduce taxes for small businesses, and make the formal registration process faster and easier should be promoted.

In addition, organising the informal sector operators would help the central bank in its financial inclusion drive as well as its cashless policy.