Releasing the bottleneck to economic growth
SOUTH AFRICA FACES two major challenges to economic growth, namely labour constraints and high levels of informality. This is according to Harvard’s Professor Michael Porter, speaking at the University of Pretoria’s Gordon Institute of Business Science recently. Small, Medium and Micro Enterprises (SMMEs) play a significant role in the country’s economic performance, productivity and as a source of livelihood and employment for many South Africans, with many SMMEs belonging to the informal sector.
The informal sector or second economy can be described as the enterprises that are not legally regulated by the institutions of society in a legal and social environment in which similar activities are regulated, i.e. it is neither taxed nor monitored by the government and is not included in the government’s GNP. By contrast, the formal or first economy is a set of economic activities that are recognised by the state.
Research undertaken by Dr Frank Aswani, a recent GIBS MBA graduate, shows that the informal sector in Africa is growing while the formal sector is stagnating. While informal employment helps to alleviate poverty, the jobs are often low quality and do not fit within the International Labour Organisation’s definition of “decent work”. Informal enterprises also operate outside of the governmental system of regulations, restricting their ability to incorporate them in policies and strategies in pursuit of national socio-economic goals. The failure of informal operators to comply with regulations that protect employment, the environment and consumers, lowers the ceiling on the quality of their development and their potential for growth and wealth accumulation.
While the first economy in South Africa is modern and integrated with the global economy, the second economy is not. The first economy is unable to reduce poverty quickly on the massive scale needed, however, so robust intervention in the second economy is necessary for the gap between the two to narrow.
The experience of countries such as Spain which have successfully reduced their informal economies suggest a need for a threepronged approach; reducing the burden of formality by reforming the tax system and labour laws, improving the enforcement of laws and regulations and creating a culture of formality by raising popular awareness about the second economy’s harmful effect on economic development. Some of these measure should be sector specific, while others should broadly address structural problems across sectors. The benefits of formalising a business include being able to conclude legally enforceable agreements with suppliers and customers, gaining access to trade fairs, export operations and government programmes, and being able to expand your business without fear of government intervention. Benefits for governments include an expanded tax base and increased economic activity, while benefits for consumers and society include improved income distribution, enhanced health and safety standards, economic growth and an improvement in the social security system.
Robust intervention in the second economy is necessary for the gap between the
two to narrow.
The main constraint on entering the formal sector is the cost vs benefit for the individual entrepreneur. In developing countries, registered companies pay up to 80% of taxes, compared to approximately 50% in developed countries. Other costs include registration, regulations and compliance costs, business modifications, human resources, insurance and indemnities.
Barriers and facilitators to formalisation can be classified into financial and nonfinancial in nature. Non-financial barriers to formalisation include protracted registration procedures, skills shortages, utilisation of obsolete technology, poor location of businesses, limited access to markets and business support services, and lack of incentives by the government. Informal businesses also rarely get the opportunity to tender for government business.
Financial facilitators to drive formalisation are that the cost of capital is generally far higher for the informal sector than the formal, and that the informal sector often have to pay as much as 15% of their gross income in bribes to corrupt officials.
Non-financial facilitators to drive formalisation including improved access to skilled labour, capital and legal advice, as well as regular inspections by the government which would incentivise enterprises to comply with regulations and therefore level the competitive landscape. The provision of secure business locations served by public transport would enhance markets, as would government efforts to provide a reliable market, technology transfer, training and supervision.
The informal sector is seen as the only source of income for many South Africans. Formalising this sector would release the bottleneck to economic growth that is sorely needed to reduce the massive levels of unemployment that exist.