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Informality impedes sustainable development, says IMF

Clara Nwachuwu

Despite that about 60% of the global workforce are engaged in the informal sector, recent research has shown that informality hinders sustainable development particularly in emerging markets and developing economies, according to the International Monetary Fund (IMF).

This is because it affects how fast economies can grow, develop, and provide decent economic opportunities for their populations and is linked to poverty, and inequality, including gender inequality. Also, firms operating in the sector do not contribute to the tax base and tend to remain small, with low productivity and access to finance.

Findings reveal that countries like Nigeria’s, where the informal sector is estimated at about 65% with high informality tend to grow less than their potential.

Accordingly, sustainable development, the IMF said, requires a gradual reduction in informality over time, because the informal sector is currently the only viable income source for billions of people.

A publication titled: The Global Informal Workforce: Priorities for Inclusive Growth, assesses the informal economy around the world and its impact on the macro-economy. It covers interactions between the informal economy, labour and product markets, gender equality, fiscal institutions and outcomes, social protection, and financial inclusion.

Specifically, “Informality is also related to gender inequality: in two out of three low- and lower-middle income countries, women are more likely than men to be employed informally and to be in the most precarious and low-paid categories of informal employment.”

The report further cited the United Nations (UN) Women finds that the gender wage gap is 28% in the informal sector in sub-Saharan Africa, far higher than the 6% gap in the formal sector.

“High informality is, moreover, associated with high inequality: workers tend to earn less in the informal sector than formal sector peers with similar skills, and the wage gap between formal and informal workers is higher at lower skill levels,” the report said.

Also, because informal workers lack formal contracts and social protection and tend to be less-educated, they are more likely to be poor and to lack decent work conditions compared with peers in the formal sector.

The International Labour Organization (ILO) estimates that globally, 85 percent of informal workers are precariously employed in small, informal firms, with only 11 percent of informal workers employed in formal firms.

Therefore, “Providing workers with decent jobs and facilitating the transition of small firms to formality is thus urgently needed to support inclusive development, as acknowledged in the United Nations’ Sustainable Development Goals.”

In her foreword to the book, Managing Director, IMF, Kristalina Georgieva, said: “Reducing informality over time is essential for sustained and inclusive development, but this process will inevitably have to be gradual, given the importance of informal activities to the livelihoods of billions of people currently.

Indeed, the informal economy is estimated at about one-third of the global economy. According to the ILO about 2 billion workers, or 60% of the total employed population age 15 years and older, operate in the informal sector.

Consequently, Georgieva insisted that this sense of urgency has now been reinforced by the COVID-19 pandemic, stressing the need for governments to urgently provide a lifeline as a matter of priority.

She said: “The pandemic has crushed informal activities, particularly in developing countries, where large segments of the population are not covered by existing social protection schemes.

Strict lockdowns destroyed the livelihoods of taxi and minibus drivers, street and market vendors, and bar and restaurant owners depending on daily incomes for survival.”

The IMF boss also argued that the pandemic offers an opportunity to leverage digital solutions to: set up more permanent mechanisms to expand social protection; and provide vulnerable individuals or firms with adequate incentives to join a national register as a step toward formalization.

“Other tools can include a combination of support to small and medium-sized enterprises (incubators, preparation of financial accounts), as well as tax policy, and administration measures (adequate minimal threshold for VAT, simplification of tax payment procedures, incentives to be part of the taxpayer registry).”

High informality is, moreover, associated with high inequality: workers tend to earn less in the informal sector than formal sector peers with similar skills, and the wage gap between formal and informal workers is higher at lower skill levels.

Addressing informality

Editors of the research, Corinne C. Deléchat and Leandro Medina, therefore raised four broad policies to effectively address the root causes of informality, including:

  • Improved access to and quality of education is probably the single-most powerful way to lower informality. Education reforms aimed both at enhancing equality of access and ensuring that students remain in school until the end of the secondary cycle are particularly important. Ample technical and vocational training opportunities will also help.
  • Tax system design should avoid inadvertently increasing incentives for individuals and firms to remain in the informal sector, as simpler value-added and corporate tax systems (with lower rates and no or minimal exemptions and loopholes), as well as low payroll taxes, help reduce informality. Supportive social protection systems, including progressive income taxes and protection for the poorest, help address distributional aspects.
  • Policies to enhance financial inclusion by promoting expanded access to formal (or bank-based) financial services can help lower informality. For informal firms and entrepreneurs, lack of access to finance is a key constraint, stifling productivity and the growth of their businesses. Countries where access to finance is broader tend to grow faster and have lower income inequality.
  • A range of structural policies can help increase incentives and lower the cost of formalization. Labour market regulations can be simplified to ensure greater flexibility and facilitate informal workers’ entry into formal employment.

The researchers also found that competition policy can boost entry of small firms in some sectors by eliminating monopolies as well as excessive regulations and bureaucratic requirements.

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