Three Ways Policymakers Should Support Informal Entrepreneurs In Emerging Economies

Saul Estrin is Emeritus Professor of Management Economics and Strategy at the London School of Economics and Political Science, Maribel Guerrero is Associate Professor of Public Policy and Management at the School of Public Affairs and Global Center for Technology Transfer at Arizona State University and Tomasz Mickiewicz is Professor of Economics at Aston University. They have published new research on opportunities for informal entrepreneurs in emerging economies.

Gianinna Osorio is one of hundreds of thousands who support informal entrepreneurs in emerging economies across the world.

She is a real estate broker in Chile. Her company offers free financial advice to informal entrepreneurs, among others, who desperately need support.

Companies like Gianinna’s play a vital role. The firms of informal entrepreneurs operate under the state’s radar.

In some parts of the world, such as Sub-Saharan Africa, Latin America and South Asia, they make up as much as between 60% and 90% of non-agricultural employment.

Informal entrepreneurs are often motivated by business opportunities, but many are driven by a lack of attractive employment prospects.

Three guidelines to support informal entrepreneurs

Policymakers can do much more to support informal entrepreneurs in emerging economies, as our research shows.

Registration

Policymakers should make existing informal sector entrepreneurship, seen as a temporary phase of entrepreneurship, legal and attractive rather than just allowing it. This can be achieved by removing initial requirements associated with formal registration. The need to register could be gradually imposed above certain revenue thresholds.

It would also be beneficial for local communities to have a greater role in the registration and taxation of new and small businesses. For instance, if an ethnic minority group in a specific area is provided with the necessary tools to create conditions for registration, then the income generated from it should remain within that community.

Elimination of excessive regulations and bureaucratic requirements also helps. Regulations are more likely not to be followed when government is seen as remote. Policymakers need to consider how much trust people have in government administration at its different levels (i.e., local, central) because trust will have a significant impact on incentivising people to formalise their activities, particularly because local communities are often trusted more than the central government.

Improve tax systems

Authorities should consider the unintended consequences that may encourage individuals and companies to remain in the informal sector. Simple tax codes with low rates and a low payroll tax can help. It is also critical to establish supportive social protection systems that include progressive income taxes and protection for those in the most vulnerable positions to address issues of distribution, and at the same time create incentives to support oneself through entrepreneurship so that the entitlements are not lost at low levels of entrepreneurial income and are reduced gradually as income raises.

Allowing tax breaks until sometime after registration would also help, while ensuring they are individual or household specific limits that could mitigate opportunism such as repeated registration. However, we place the emphasis on the role of the informal sector in innovation: the latter will be supported through experimentation if an initial informal stage is allowed.

Improve equality and inclusion in structural policies

To support sustainable development, various structural policies require investment in education equality, financial inclusion, labour market and technology policies that increase returns, incentives, and decrease costs. These can include:

• Improving education outcomes through reforms that prioritise equal access and encourage the population to complete at least technical and vocational training.
• Improving financial inclusion through reforms that enhance minorities’ access to formal financial services, which can reduce informality and increase growth expectations for firms and entrepreneurs.
• Improving the labour market inclusion through reforms that simplify and make it easier for informal workers to enter the formal job sector, creating a more flexible and inclusive workforce.
• Improving technological inclusion by using digital platforms and open innovation, including government-to-person mobile transfers, which empower minorities financially, help new enterprises grow, and produce synergies with financial inclusion.
• Improving crisis management policy design. As the experience of the COVID-19 pandemic demonstrated, a rapid yet well-designed response to crisis is important for businesses and for creating incentives to stay formal.

Change through practice

Governments aren’t the only agent of change. There is an important role for socially oriented entrepreneurs, such as Gianinna Osorio, who make crucial information more accessible to informal entrepreneurs. Efforts like Gianinna’s enhance informal entrepreneurs’ chances of survival and their ability to grow and formalize.

A gradual shift towards increased formality, or a reduction in informality of new firms over time, will contribute to sustainable, dynamic, and competitive growth at both new business and country levels. This shift will also foster inclusion and equality.