A Note on the Informal Sector

It is an enduring question why many informal businesses in developing countries choose to remain informal, and what gains in productivity or profitability they forgo as a result of that choice. Some mid-20th-century research into these questions suggested that informal businesses were merely survival strategies without much prospect for growth. Later work, such as the that of De Soto, suggested that informal firms were by and large led by micro-entrepreneurs unable to break out of low productivity because of the barriers to formalization.

More recently, La Porta and Schleifer have tempered that optimistic view by finding it unlikely that informal firms would reap any productivity gains by formalizing, arguing instead that they were categorically different from their formal counterparts. Our analysis focused more on the differences between countries and found a more nuanced view: in some countries, like in East Africa for instance, informal firms were not that different than formal firms; in South Africa, the difference was stark.

The work presented in this note analyzes fresh data made available by more comprehensive Enterprise Surveys of formal firms of various sizes and, importantly, of informal firms. We provide more fine-grained insights into differences in characteristics and productivity levels between formal and informal firms or different sizes in different developing countries.

The responses presented here come from five countries, the Democratic Republic of Congo, Ghana, Kenya, Myanmar and Rwanda, as reported by World Bank’s Enterprise Survey datasets. The oldest survey is Rwanda’s, from 2011 and the most recent one is Myanmar’s, from 2014. (`Don’t knows’ and refusals to answer were treated as missing observations for this analysis.)

Hover over the charts for more information about each country’s response.

Access to electricity

The majority of informal firms in our five-country sample use electricity in their operations, ranging from 52% of firms in Kenya to 80% of firms in Myanmar.

Most of the informal firms that use electricity also report being connected to the electricity grid: close to all informal firms in Myanmar and Ghana are connected; Rwanda has the lowest share of grid-connected firms with 65%.

Power outages appear to be commonplace in all five countries. On average, 83% of informal firms experienced a power outage in the last month. We observe little difference when it comes to the number of power outages experienced per month between formal and informal firms in the five countries we analyzed. In Ghana, informal firms appear to experience somewhat more power outages, with a median of 7 per month compared to a median of 12 per month for informal firms. In Myanmar, we observe the opposite trend: the median informal firm reports 5 power outages per month, while the median formal firm reports 10. Kenyan and Rwandan firms report the fewest monthly power outages, with 4 and 3 power outages respectively and little difference between formal and informal enterprises.

Informal firms appear to experience somewhat longer power outages in the DRC and in Ghana. In Kenya, Myanmar, and Rwanda, the duration of power outages is similarly long for both formal and informal firms, and in some cases, they are reported to be shorter in the informal sector. Ghana’s power outages last the longest, with a median duration of 6 hours, followed by Kenya with a median of 4 hours.

Generator ownership is fairly common among large firms (20+ employees) in all five countries, with over 70% of large companies reporting to have at least one. There are large differences in generator ownership between informal firms, however, and they appear to show little association with the frequency or duration of power outages. Generator ownership among informal firms in Rwanda and Myanmar is high, with 40% and 59% respectively. In contrast, less than 10% of informal firms own a generator in Ghana, Kenya, or Rwanda.

Access to water

On average, about a third of informal firms use water for their operations. Informal firms are most likely to use water for their operations in Ghana, at 39%, while firms in Myanmar are least likely to do so, at only 21%.

The share of informal firms that experiences insufficient water supply during the last month differs greatly from country to country. It is least likely to be a problem for firms in Myanmar, with only 17% of informal firms reporting that water supply was an issue. At the same time, three-quarters of informal firms in Ghana did not have sufficient water during the last month.

Access to finance

While we observe few differences between formal - particularly small formal – and informal firms when it comes to access to electricity and water, the differences in access to finance are striking. Compared to formal firms of any size, only a fraction of informal firms reported owning a bank account. While bank account ownership among registered firms in Ghana and Kenya is close to universal, only 40% of Ghanaian informal firms and 35% of Kenyan informal firms have a bank account. Though bank accounts for formal firms are less ubiquitous in DRC, Rwanda, or Myanmar, large gaps in access remain between formal and informal businesses.

The differences between small formal and informal firms in access to loans are less dramatic or consistent than for bank account ownership, but still show a large disparity in financial opportunities, particularly in Kenya and Rwanda. On average, fewer than one in twelve informal firms has access to credit.

Crime

On average, about a quarter of informal firms from the five countries in our analysis consider crime a severe obstacle to their operations. Crime was most likely to be named as an obstacle for informal firms in Rwanda (36%) and it was most likely to be considered a severe problem in Myanmar (7%).

Rwandan informal firms were also the most likely to report a loss from crime in the last month, with 13.8% doing so, while only 2% of informal firms Myanmar recalled crime-related losses.

While their responses are not directly comparable, the views of formal firms on crime highlight some potential differences. When asked to rate the severity of crime, theft, and disorder as an obstacle to their operations on a scale from 0 (no obstacle) to 4 (very severe obstacle), formal firms rated it as not a severe issue, with an average score of 0.9 across our five countries. In fact, 51.5% of formal firms considered crime to be “no obstacle”. Here, formal firms in the DRC saw the biggest problem, with an average score of 1.5 on the 0-to-4 scale, followed by firms in Kenya. Similarly to their informal counterparts, formal firms in Myanmar were the least concerned about crime as an obstacle, with 78% of registered businesses rating it as “no obstacle”. Differences in crime perceptions between formal firms of different sizes tend to be small.

Firm productivity

In most cases, sales per worker at informal firms are considerably lower than sales per worker at small (<10 employees) formal firms. The one exception is the DRC, where the value of sales per worker (at the median) at informal firms is comparable to that of small formal firms, at around $1,800 per year. Also uniquely for the DRC, the lowest values of sales per worker are seen among formal firms.

Kenya and Rwanda exhibit the largest differences between sales per worker in small formal firms and informal firms. At the median, a worker at a small formal firm in Kenya is over eight times as productive as a worker at an informal firm; in Rwanda the same ratio is over twelve. Sales per worker in USD (non-PPP) terms are the lowest in Rwanda overall, with only $900 per year at the median.

As expected, median sales per worker at larger formal firms are multiple times that of the median of informal firms. Here, Myanmar constitutes an exception: at the median, large (20+ employees) formal firms are barely more productive than informal ones. In contrast, in Kenya, large firms are thirteen times more productive than informal ones; in Rwanda seventeen times as much.

While in most cases sales per worker increases with firm size among formal firms, in Kenya medium-sized formal firms (between 10 and 20 employees) appear to generate lower amounts of sales per worker than small formal firms (<10 employees).

In terms of the number of employees, even small formal firms tend to have significantly more employees (about 6) than informal firms (about 2). In Myanmar, the number of median informal firm employees is slightly higher, at four.

Owner characteristics

Informal firm owners are not as young as one might assume - the average age is 39 (the median age is 37). The median age among owners is somewhat lower in Kenya and Rwanda (34 years), while higher in Myanmar (42 years).

The top manager (who is often the same as the owner) at an informal firm is reported to have six years of experience in the sector at the median. Similarly to the age data, managers at firms in Myanmar tend to have the longest experience in their sector, with a median of 10 years.

There are large differences between informal firm owners’ level of education across the five countries. An astonishing 37% of informal business owners report having some university-level education in Myanmar and close to 25% do so in the DRC. In Ghana, Kenya, and Rwanda the share of university-educated owners is below 5%.

Interestingly, in the DRC 19% of respondents say that their parents attended university; this share in Myanmar is much lower, at only 4%.

It seems that the skills for managing a business - and perhaps the business itself – is passed on from one generation to the other. The responses suggest that over one-third of current informal business owners' parents also owned a business. This was most likely to be the case in Ghana, where 48% of business owners had parents who also owned a business. In contrast, only 24% of DRC respondents has business owner parents.

Across all five countries, informal firms are more likely to have a majority female owner than formal firms of any size. Close to two-thirds of unregistered businesses in Ghana report being majority female owned, while about one-third of informal firms in Kenya, Myanmar, Rwanda do so. Female ownership seems particularly low among large formal firms.

Benefits of registration

About half of informal business owners said that they would like to register their business. Rwandan informal firm owners are the most likely to express a desire for formalization (56%), while owners in Myanmar are the least likely to do so (38%).

Better access to finance is the most recognized benefit from registration across the board, but the share of firms who see it as an advantage of formalization differ greatly from country to country. Over 90% of Rwandan informal firms see better access to finance and loans as a benefit that could be obtained from registration, but only 41% in the DRC do so, and even fewer firms – only 24%- in Myanmar see it the same way.

Over 60% of informal firms in Kenya and close to half of those in Ghana and Rwanda see better access to raw materials and services as a benefit to be gained from registration. For respondents in the DRC and Myanmar, this is seen as a less tangible benefit.

Only a relatively small share of informal firms appear to believe that formally registering their business would result in fewer bribe payments. Rwandan firms were the least likely to name this as a benefit from registration, with less than 9% of respondents doing so, while about 40% of Kenyan businesses thought that formalization would reduce the number of bribes paid.

Around 40% of informal firms in Ghana, Kenya, and Rwanda believed that the ability to issue receipts and thus attract customer would be a benefit of formalization. Rwandan firms were less likely to see this as a potential advantage than others, with only 20% responding positively.

Registration requirements

How accurate are informal firms’ perceptions about the formalization process? We compare firms’ own estimates with the World Bank’s Doing Business data on registration requirements to pinpoint some interesting differences between expectations and realities.

Most respondents believed that it would take 30 or fewer days to register a business, but there is a wide variation between and within countries. On average, Kenyan firms expected the fewest number of days to complete registration, with a median of 7 days, while firms in the DRC expected it to take the longest, with a median of 30.5 days.

The difference between owners' expectations and reality of registration varies cross countries. In the DRC and Ghana, expectations regarding the days needed to register match reality. In Kenya and Myanmar, respondents underestimate how long registration would take. In Kenya, the Doing Business expert estimates put the days needed to register at 32, which is 25 days more than the median informal firm estimate. In Myanmar, experts’ estimate that registration will take 72 days – informal firms (at the median) believed that 15 days would be sufficient. At the same time, informal firms in Rwanda overestimate the number of days needed to formalize their business: the median estimate was 30 days, while businesses can register in just 2 days.

Looking at some further registration requirements listed in the Doing Business databases, such as the cost and minimum capital required for registration in our five countries, it is not difficult to imagine why some firms have continued to operate informally.

Rwanda stands out as the country with relatively simple and affordable registration requirements. There are only 2 procedures needed to register a business, and the cost is around $30. In contrast, administrative and financial barriers to formalization appear prohibitive for the vast majority of the population in the DRC and Myanmar. In both countries, registrants need to complete 11 different procedures and face significant costs – about $400 in the DRC and $1,000 in Myanmar. This is in addition minimum capital required for business, which the World Bank’s data indicates to be $60,000 in Myanmar and $2,000 in the DRC. The cost of These large barriers to registration may help explain some of the unexpected responses we have seen in these two countries, for example the high share of university educated informal firms owners in both places.