Developing the informal sector is not a nice-to-have but a must-have

28 Sep 2020

The performance of our informal sector is intimately linked to the rest of the economy. This fact has profound implications for public policy.

There exists in South Africa a comforting myth that the informal sector serves as a “fallback” for those who have lost employment in the formal sector. The National Development Plan states that the informal sector “provides a cushion for those who lose formal sector jobs or need to supplement their formal incomes during crises”.

This has led some to argue that, given the devastating consequences on the formal economy of the Covid-19 pandemic, the accompanying lockdown and the myriad restrictions on economic activity, people can create or find jobs in the informal sector.

The Black Business Council, for example, thinks that “parts of the informal sector have proved resilient” and that “those businesses that have been worst hit are the formal sector SMMEs”. Similarly, the International Labour Organisation suggests that “informal employment tends to increase during crises”.

These views are misguided and contrary to the available evidence in South Africa. The reality is just the opposite: the performance of our informal sector is intimately linked to the rest of the economy. This fact has profound implications for public policy.

Andrew Charman, director of the Sustainable Livelihoods Foundation, has been studying the informal microenterprise sector in Delft in the Western Cape over the past decade. Charman explains that “when our formal economy goes into recession, this has a dramatic impact on our informal businesses”.

This assertion is backed up by national data. Economists Caroline Skinner and Michael Rogan show that in the aftermath of the 2008 global financial crisis, employment in South Africa’s informal sector declined by more than that in our formal sector.

A steady wage in formal employment would mark a significant improvement in the quality of life of millions of jobless South Africans.

It is imperative in this context for policymakers to understand that, while some people have recently exploited opportunities to start businesses or find jobs in the informal sector, this will not offset the loss of formal sector firms and their expansion and productivity. There are three important considerations to keep in mind.

The first is that formal employment is the best vehicle for improving opportunities for poor people. Formal employment is likely to offer workers better prospects for career progression and future income earnings. Formal jobs have a better chance of enhancing employability by providing better skills and training than a job in the informal sector. By contrast, informal employment tends to be characterised by greater instability, with a greater proportion of people doing odd jobs in a more unstructured way. Formal employment can also provide essential protection for workers against unsafe and undesirable working conditions. Thus, if it can be made accessible to unskilled jobseekers, formal employment would offer a more stable and preferable ladder out of poverty.

A steady wage in formal employment would mark a significant improvement in the quality of life of millions of jobless South Africans.

These realities should not be taken as an argument to shut down informal employment, which is something South Africa can hardly afford, but rather as a call to prioritise the rapid expansion of parts of the formal economy that could generate millions of new jobs for the unemployed. Aside from striking oil, the one tried-and-tested method for developing countries around the world – from South Korea to Mauritius – to escape from poverty is labour-intensive growth. This is where our focus should lie.

The second reality often ignored by promoters of the informal sector is that the growth and sustainability of small informal firms depend to a large extent on an expanding formal sector. The two sectors do not exist in isolation; they are inextricably interlinked. At the most basic level, for instance, incomes in the informal sector are driven by disposable incomes of consumers and households, most of which are derived, ultimately, from formal sector sources. This is one reason the informal sector takes a hit when the formal sector is in a downturn.

The final consideration is that South Africa’s informal sector is extremely small and unproductive by global standards. According to Statistics South Africa, its contribution to our GDP is only 6%, making it much smaller than the majority of other developing countries and smaller even than many developed countries. India’s informal sector contribution to GDP is 42%, the UK’s is 10% and the average for sub-Saharan Africa is 55%.

...However, in a context where we had 40% unemployment and 70% youth unemployment (on the broad definition) before Covid-19 struck, any state action to restrict legitimate informal sector activities is perverse.

South Africa’s informal sector is also weaker at serving as a launch pad for new firms with growth potential than elsewhere. In work commissioned by the Centre for Development and Enterprise, development economist and informal economy expert Professor Colin Williams found that 85% of South African businesses start unregistered in the informal sector, compared with 93% in Brazil, 99% in India and 98% across the rest of Africa.

These interrelated factors imply that the informal sector is not a sufficient buffer to a severe drop-off in formal sector economic activity. Already, indications from the large NIDS-CRAM study are that four times as many jobs have been lost in this country due to the coronavirus crisis than were lost as a result of the global financial crisis. The vast challenges of unemployment, poverty and inequality have deepened, broadened and metastasised.

Expanding the informal sector is therefore not an alternative to growing the formal sector.

However, in a context where we had 40% unemployment and 70% youth unemployment (on the broad definition) before Covid-19 struck, any state action to restrict legitimate informal sector activities is perverse.

The most useful short-term policy intervention is to minimise state harm to informal firms, many of which are routinely extorted out of business by ideological, corrupt or xenophobic city officials or police. If government, especially at the local level, left alone all but the most problematic of informal activities, more people would be able to generate livelihoods in this sector.

In the longer term, government should be looking to enable informal entrepreneurs with potential, rather than discouraging them from operating.

This will require speedy action on deregulation – as promised by the president in February 2019, although since then we have fallen even further in the Doing Business Index (from 82nd to 84th) and have yet to see any action with respect to reducing the costs of doing business in the country. It is only in a supportive environment that informal businesses will begin to voluntarily formalise at scale, and in that way help to get the country on to a more inclusive growth path. DM

Ann Bernstein is head of the Centre for Development and Enterprise. This article is based on a new CDE publication: South Africa’s informal sector in the time of Covid-19.

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