By Tabea Lakemann, Research Fellow, GIGA Institute of African Affairs and University of Göttingen, and Jann Lay, Acting Director, GIGA Institute of African Affairs, and Head of GIGA Research Programme Growth and Development
Learn more about this timely topic at the upcoming
17th International Economic Forum on Africa
The potential of informal firms
On average, the informal economy is estimated to make up almost 40% of GPD in Africa.2 Informal firms are typically much smaller than formal ones, but even when controlling for size, they are on average less productive, less likely to access external finance and have less educated managers.3 At the same time, heterogeneity between informal firms is considerable. Some firms exhibit very high marginal returns to capital, and between 28% and 58% of informal entrepreneurs in West Africa are identified as “constrained gazelles” with low capital stocks, but some unrealised growth potential.4 Many informal firms thus have the likely potential to provide an improved livelihood to their self-employed owners and family members engaged in the business.
However, creating a large number of decent jobs requires self-employment to become considerably more productive and be replaced by a significant expansion in paid employment, ideally in formal firms. Such firms may grow out of informality and, actually, in a number of countries, the proportion of formal firms that started as informal is higher than expected. In Nigeria and Uganda, for example, this share is well above a third of formal firms (Figure 1). This demonstrates again the potential of selected informal firms. Yet, low permeability from informal to formal enterprise sectors in many countries has consequences. Governments lose out on the opportunity to tax significant portions of GDP. The majority of entrepreneurs do not enjoy the benefits of formality, such as easier access to finance and government services. And the majority of employees are not protected by labour regulations.
(Employment) growth is in services, not manufacturing
Industrialisation is at the forefront of policy agendas, yet data for 11 African countries5 show that service sectors have seen the strongest employment growth since the 1960s, while employment in manufacturing has not grown consistently. The size and the composition of the service sectors differ between countries and change with economic development. As Table 1 illustrates for 2010, a first group consisting of three upper middle-income economies has large service sectors (50-65% of total employment) that are relatively diversified. Non-negligible shares of the workforce are active in business services, the most productive category. Group 2, consisting mainly of lower middle-income economies, also has sizable service sectors (35-45%), but service sector employment is mainly in trade services,6 the single largest, and relatively low-productivity, category in all countries. Group 3, consisting mainly of low-income economies, has smaller service sectors (15-25%) with the majority working in agriculture.
Services and informality
Informality and low productivity in services are closely linked. It is well established that urban informal (self-)employment is dominated by petty services, particularly retail trade.7 However, systematic knowledge on the overlap and interlinkages between (in-)formality and the service sector is still limited. Such knowledge, however, is important to understand (potential) productivity growth in services. Table 1 suggests evidence that the relationship between service sector employment, informality and productivity may be non-linear. It shows that relatively rich (i.e. productive) Group 1 countries with large service sectors have the smallest informal sectors. If anything, it seems that larger service sectors at lower middle-income levels do not correspond to smaller informal sectors. Ghana and Senegal, with more than 20% of the workforce in trade services, have relatively large informal sectors making up roughly 40% of GDP. Moreover, and in line with these assertions, productivity differentials within the service sector are large in Group 2 and even larger in Group 3, suggesting the co-existence of low- and high-productivity services.
Table 1: Employment shares in 2010, % of total employment, and Informal economy, % of GDP.
|Group 1||Group 2||Group 3|
|WB income group||UMI||UMI||UMI||LMI||LMI||LMI||LI||LI||LI||LMI||LI|
(% of GDP)
|Note: UMI=Upper-middle-income, LMI=Lower-middle-income, LI=Lower-income.
Source: own compilation based on Africa Sector Database (employment shares), and Medina et al. (2017)ii, (Informal economy).
What is the way forward?
Strategies for economic growth and productive employment in many parts of Africa should not overemphasise the role of labour-intensive manufacturing. The reasons for that are many, including the risks associated with labour-saving technologies or simple geographical factors, such as being land-locked. But the dominance of service sectors and the prevalence of informality, two inter-related structural features of most African economies, will not go away even under the most optimistic assumptions on formal sector manufacturing growth. Thus, policies should explicitly address low productivity in service sectors. Identifying key sub-sectors and devising appropriate instruments require careful, country-specific and disaggregated analysis of sectoral productivity differentials and patterns of productivity growth. Moreover, the potential of informal firms should not be underestimated nor overestimated. Lowering barriers to formality through well-known instruments can be an important ingredient for increasing productivity in services and enabling firm growth and thus growth in paid employment. And all this is not to say that manufacturing may not be a pillar of growth in some countries. Yet, development strategies cannot ignore the structural realities of most African economies.
1.↩ “Africa” refers to sub-Saharan Africa in this post.
2.↩ Medina, Leandro, Andrew Jonelis, and Mehmet Cangul. 2017. “The Informal Economy in Sub-Saharan Africa: Size and Determinants.” IMF Working Paper 17 (156). http://www.imf.org/~/media/Files/Publications/WP/2017/wp17156.ashx
4.↩ Grimm, Michael, Peter Knorringa, and Jann Lay. 2012. “Constrained Gazelles: High Potentials in West Africa’s Informal Economy.” World Development 40 (7): 1352–68.
5.↩ de Vries, Gaaitzen, Marcel Timmer, and Klaas de Vries. 2015. “Structural Transformation in Africa: Static Gains, Dynamic Losses.” The Journal of Development Studies 51 (6): 674–88. Countries covered: Botswana, Ethiopia, Ghana, Kenya, Malawi, Mauritius, Nigeria, Senegal, South Africa, Tanzania, Zambia.
6.↩ The category of “trade services” comprises wholesale and retail trade, repair of motor vehicles, motorcycles and personal and household goods, Hotels and Restaurants.
7.↩ See Uganda’s example here: http://www.ubos.org/UNHS0910/chapter12_the%20informal%20sector.html.