By: Diego Paredes Ramírez
In countries with high rates of population growth and urban migration, the informal sector accounts for a large part of the economic activity. According to a study by the economist Jacque Charme, the informal sector represents 50% to 70% of non-agricultural GDP in developing countries. This sector absorbs the growing need to generate income and employment for more than 2 billion people worldwide (ILO, 2018).
The International Labour Organization (ILO) defines the informal economy as the diversified set of economic activities, enterprises, jobs, and workers that are not regulated or protected by the state. This sector is described based on five facts as presented by La Porta and Shelifer (2014). The informal sector is said to be characterized by having a large share of the economic activity, low productivity, disconnection from the formal economy, tax avoidance, and shrinkage when a country grows and develops.
According to Raunelli et al. (2016), small entrepreneurs are avoidant of risks and tend to overestimate their skills, which may be a hypothesis of why entrepreneurs in the informal economy leave the market quickly. Entrepreneurship in this context might be challenging. So, the challenge for an entrepreneur is to survive in the informal sector or to be productive enough to move towards formality.
For an emerging economy like Peru, which has had 113 consecutive months of economic growth (Ministry of Economics and Finance of Peru – MEF, 2018), informality is a structural problem. In that sense, the case of the city of Lima in Peru, can offer an example of the circumstances facing an entrepreneur and the constant need to produce better goods and services for the population subjected in the informal sector.
Lima’s population has grown from 5% of the national population in 1921 to 30% of the 31 million Peruvians recorded in 2017 (National Institute of Information Technology and Statistics – INEI, 2017). Likewise, it was reported that 73% of the country’s workforce works under informal conditions. This places 12.2 million people in a working environment with low wages and precarious labor conditions, 3.8 million of whom are from Lima alone (INEI, 2018). The economic activity in the informal sector is vulnerable and volatile and according to the Peruvian Society of Small Businesses (SPP), 52% of small and medium enterprises and 90% of startups go bankrupt before the third year of operations.
The way in which informality is seen as a problem is because it is associated with low productivity and poverty, and policy makers tend to link development with reducing the levels of informality. But, as with the case of Peru, it did not work entirely and there is no strong correlation between growth and reducing informality.
It is also important to specify the benefits of the formal economy for the players. For an entrepreneur, those are legal security, expansion capacity, and access to credit in the financial system. For the Government, it is related to monitoring and promoting the national production in small and medium sized companies, controlled and supervised employment, and increase in tax collection levels.
Converting an informal market to a formal one takes place and differs from country to country based on the laws and circumstances of each. The World Bank has identified the main drivers of informality in the Peruvian economy. Those are business and labor regulation to implement flexible labor laws, government transparency to eradicate corruption, and government spending in education, infrastructure, and social programs related with nutrition and health.
The different levels of government have specific tasks in terms of the fight against informality. In the case of Lima, the District Municipality of La Victoria has in its jurisdiction Gamarra – the largest textile commercial emporium in Peru, which generates US$ 5.6 million and receives more than 150 thousand people per day. This commercial zone has been characterized by being highly informal in its surroundings generating chaos, disorder and contamination. Mafias and illicit associations have taken over Gamarra, profiting by ‘protecting’ tiny spaces and charging US$ 1.5 thousand monthly per square meter on public streets and sidewalks to street sellers. Under this scenario, the new district mayor George Forsyth closed the emporium for three days to carry out cleaning, security, and control work in public spaces.
Photo Credits: andina
An important thing about this intervention, apart from having been successful, turns out to be the effect it has had on consumer behavior in Peru, because it questions the way in which people act and opens a new opportunity to fight against informality. In exchange for a low price, people are willing to receive a product or service of very poor quality encouraging its expansion. This may affect important areas such as transport, housing and health. The problem that many question about this aspect is the lack of better options in the market. Under the slight supervision of the state, which allows these goods and services to be offered in precarious conditions, disincentives are established for the creation of productive competition in these areas. Things may begin to change under the perspective of the consumer, who by using their market power could modify the determinants of the informal economy. But is not enough because it also depends on government intervention.
On the other hand, to improve productivity and to promote resilient, sustainable and scalable entrepreneurship, the state and the private sector have joined forces to provide venture and seed capital to encourage and support startups in financial and managerial capacity development. It has increased significantly in recent years, reaching US$ 9.8 million invested in 2018 and with growth expectations of 25% by the end of 2019. Thus, this presents an incentive to influence new businesses to operate under the law through financing, and by reducing the risk of initial operations. For established small and medium sized companies, the government is further supporting them through tax reduction measures, regulatory and administrative simplification, and passing laws to increase financial accessibility with banks.
Throughout Peru’s history, informality survived due to the economic crises. Today however, as the country faces continuous economic growth, the informal sector is unable to keep up and is becoming an important factor in the increase of inequality in the country. It should be noted that according to the World Bank Open Data, Peru is rank 26th in worldwide informal economies. Thus, the cooperation between academia, state, and the private sector must continuously be strengthened on a greater scale to fully tackle this matter not only in Peru, but also in developing countries to promote inclusive economic growth.
