Ideas to Action:

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Views from the Center


There are many ways to describe the economic predicament of the developing world, especially sub-Saharan Africa. But one lens above all others captures most of the key agonies of modernity in the region—inequality, anxiety about the future of work, urbanisation, overpopulation, and youth/female marginalisation. This is the lens that refracts economies into “formal” and “informal.” In Africa, as in much of the developing world, “informality” has become the dread of policymakers who are constantly told by international development agencies and consultants to “formalise” their economies.

But is “informality” such a monolithic reality that simple abolishment or metamorphosis into “formality” can happen in one fell swoop? A nuanced look at what’s actually happening on the ground, a “macro-ethnography” if you will, reveals grades and varieties among Africa’s informal operators—the dealers and brokers who keep the wheels of business moving—that challenge the conventional notions of productivity and its links with formality. It helps to start with a deep dive into the theoretical origins of formalisation itself.

What is informality—and is it really such a bad thing?

An operational definition of “informality” would be the “tendency for market-based economic activity to occur outside classical firms” (classical firms being the entities that conform to classical economic rationalisations of the firm). This definition narrows our scope to three key concerns.

First, there is the issue of productivity. Though 90 percent of all new jobs and 70 percent of all employment across sub-Saharan Africa are in the informal sector, the corresponding proportion of GDP is less than 40 percent. In fact, by some estimates, informal workers are five times less productive than formal workers.

Second, the informal sector is a major site for social inequalities. Sixty-six percent of the informal workforce is female and virtually all the extreme poor in Africa are trapped between the informal sector’s expanding footprint and retreating subsistence agriculture.

Third, the old notion that technology adoption and upskilling automatically wards off informality is under massive threat in the technologically advanced West, with half of new OECD jobs being little more than low-pay, no-benefits, short-term gigs. In a more optimistic framing, terms such as “peer production,” “co-innovation,” “co-creation,” and “creative commons” suggest an alternative economic structure in which the dominance of the classical firm as the prime locus of “advanced production,” productivity, innovation, and financial energy has been disrupted.

But why is the “firm" as an economic entity so central in the classical analysis in the first place?

Famed economist Ronald Coase believed that it had to do with transaction costs. A classical firm is fundamentally a shield from the harsher elements of open market competition and uncertainty. When economic actors can gain an advantage by coordinating their production outside the open market, they build firms. Strategic management, then, is the skill needed to stretch as far as possible the conditions in which the cost of each marginal transaction inside the firm undercuts the open market in order to earn continuous rents. Those conditions tend to be related to the size of the firm, internal costs of training, rewards internalisation, trust, tribalism, and so on. When conditions diverge from the ideal, strategic managers form a network with other firms that behaves, in the barest essentials, like a single firm, using webs of contracting relationships to concentrate information for sale at a profit on the open market.

The complexity, yet parsimony, of this process invoke biological metaphors. Faced with increasing internal dissonance as they grow, firms, like living organisms, seek a balance between stability and adaptability by finding ways to concentrate energy and information behind boundaries that allow selective exchange with the environment.

The superior ability of firms to blend and centralise information and ultimately shape large zones of the environment (such as countries), in the manner explained by Ricardo Haussman and his collaborators, to reduce some of the attrition forces acting against the firm, especially by creating complex products not possible through loose exchanges in the marketplace, would seem to depend on some kind of immune system within the firm regulating internal consistency whilst allowing deeper assimilation of open market elements into firms and closed networks of firms. Economies of scale, in this model, drives economies of scope. That’s why the average worker in the US operates in an organisation composed of a hundred individuals whilst the average worker in India works in a five-person entity.

At the same time, just as a cell’s ability to replicate and diversify internally is subject to a natural constraint called the Hayflick limit, at which point the cell enters senescence, so are firms constrained by the tendency of self-regeneration to slow and then decay. Rather than concede to the forces of fragmentation, however, firms can escape the volume/surface-area trap by entering into more open, complex, networks—provided their immune system can withstand the technological and parasitic shocks in these emerging ecosystems. The prize, if they succeed, is complex, knowledge-intensive goods.

In this type of analysis, informal enterprises and entrepreneurs are doomed because they lack the immune capacity to shield themselves through such complex networks. They are weak and atomised, and are thus condemned to low productivity and subsistence goods and services.

In fact, empirical studies have shown that 97 percent of informal entities, as defined by the development industry and its literature, sell to individuals and not to other businesses. Less than 9 percent co-agglomerate with formal, wealthier, firms, and 84 percent have only a few miles reach. Worse still, not only are informal enterprises and entrepreneurs doomed in their current state, their route to formalisation is nonexistent. Indeed, a rigorous granular analysis of informal entities in an African setting found that only 4 percent have serious growth potential (18 percent if the criteria is loosened).

Perhaps governments are intuitively aware of this reality, hence their lukewarm and haphazard formalisation policies even as they pay lip service to development agencies’ exhortations.

Formalisation in the developing world is seriously hampered by an obnoxious regulatory regime, according to Sally Roever and Caroline Skinner. This would seemingly vindicate the claims of neoliberal thinkers like De Soto about the role of government ineptitude. Nothing else can account for why licensing regimes tend to be inaccessible to 98.6 percent of informal sector operators in Kenya, or why barely 2 percent of vendors in São Paulo, Brazil, succeed in regularisation attempts. Not surprisingly, there are reports circulating in government circles in Kenya that opaque contracting and public procurement have killed 100,000 SMEs, effectively obstructing the natural lane of growth for informal entrepreneurs.

Unless, of course, governments have also looked at the data and realised that informal operators do not produce any surplus income to be taxed, the most-often touted public benefit of formalisation. In an economic survey of Kampala, Uganda, it was discovered that nearly 70 percent of microenterprises earn below the tax net threshold anyway, much less generating enough profit to be taxed.

What exactly would “formalisation” mean in such a context? Certainly not the “register and tax” model that gets thrown about casually during conversations about “widening the tax net” and reducing “vulnerable employment” by increasing access to social security.

So, while it is certainly a tragedy that 84 percent of female workers and 70 percent of male workers in the informal category are certainly vulnerably employed, descriptive analysis of the problem contain no structural vision for alternative paths to a better future. Yet alternatives are all around us.

Unpacking the assumptions of firm theory

The problematic connections between many of the assumptions underlying classical firm theory are exposed in work by Yonchai Benkler, Charles Sabel, Ronald Gilson, and Robert Scott, among others.

Sabel and his co-authors argue that the real sites of interest—the most intense locations of new product and business model generation—are the interstices between firms rather than inside firms. Whereas firms once formed strong lattices to keep value from escaping their network, they now operate in a world that looks like the interstitial environment of the living cell. The high operational volatility and strategic uncertainty brought about by rapid shifts in technology and talent diffusion have made old-style inter-firm vendor relationships increasingly fragile and porous, and prompted co-production/co-innovation modes that are disrupting the traditional concept of “customer relationship ownership.”

No more do firms simply source for inputs, transform them internally, and then output finished products for sale to unilinear customers. Nowadays, products are jointly developed, manufactured in dispersed locations, and assembled and reassembled at multiple nodes in the supply chain, sometimes even within the putative customer’s own location. Products from one supplier are co-operated with components from other suppliers without any direct scope of legal engagement among these informal collaborators. Due to ever-present uncertainty about future market trends, long-term rigid procurement and supplier relationships are no longer viable. What is critical is to build enough trust within as broad an ecosystem as possible to explore possibilities together. Innovative forms of legal contracting and IP framework agreements are emerging to support these new unconventional scenarios.

In short there has been a great unbundling and massive disintermediation of the supply chain that render neat, linear, legal relationships between lattices of firms increasingly marginal, sometimes even obsolescent, in the emerging knowledge economy.

Benkler reinforces these arguments with evidence from the world of open-source software showing that loose, cellular, communes now routinely outperform tight-knit firms and inter-firm networks in terms of product performance and complexity.

But a more powerful, almost contrarian, idea is that not all “informality” is created equal. There is indeed a classical informal sector largely dominated by the poorly educated, the disenfranchised, and the politically excluded. They are unable to influence regulations and policies, and worse of all, they certainly struggle to specialise cooptively so that they can form broad, complex, networks to generate high-value, knowledge-intensive, products, services and models. In Africa especially, this talk of supply chain unbundling therefore seem self-indulgent. It is hard to see informality as a result of such trends, not when more obvious accounts of disorganised urbanisation, schooling without education, rapid population growth, and poor terms of trade abound. The central question posed by this essay is whether this is indeed the entire picture.

Africa’s informal and productive deal brokers

Anyone who has done business in Africa is aware of a dualist informality: there is the undifferentiated mass of poorly tooled graduates slowly sinking into petty trading (after years of resisting) and then there is the class of operatives called “connection (wo)men,” “hustlers,” “deal brokers,” and any number of other designations, who make the wheels of the economy turn, at least outside the small segment of the economy dominated by rigid multinational and domestic elite corporations and their lattice supply chains. Many important transactions are brokered through the agency of these hustler-maven-rainmaker operators every day, ranging from property sales and credit guarantees to forex hedging and customs clearance.

Alongside the grey-area operators are the numerous “briefcase business owners” who have none of the formal features of firms but succeed in winning contracts, subcontracting parts of them out, assembling flash teams, and delivering with a fair amount of success.

The African economy turns on these relatively higher productivity informal arrangements, but they have been rarely studied. And, not surprising, these powerful structures of market intermediation have never been considered on the roadmap to formalisation, except in general lamentations about amorphous tax evasion concerns and evils. Properly analysed, some of these brokering activities being undertaken by these entities should be happening in firms, and if they had been, they wouldn’t have been taxable anyway as they are invisible inputs.

So whilst it is true that the tenderpreneurs that everyone in Kenya rails about, and the much-lamented yahoo boys in Nigeria, are easily conflated with other rainmaking trends and the totality dismissed as uninteresting underworld phenomena, that attitude obscures a vibrant ecosystem, the greater proportion of which has nothing to do with criminality.

And until economic and political elites understand that there is a high-productivity zone emerging from the informal sector and a growing use of firms merely as shells for loose transactions completely outside the bounds of classical firm theory—and acknowledge the flow of talent from firms to “loose consortia” of microcontractors, freelancers, “flash firms” (shells set up for specific activities and then allowed to lapse)—official development strategy shall fail to ditch the discredited view of a linear path from informality to formalisation.

Sharp observers will grasp that in many African economies, the role of most firms outside the small cream of multinationals is as middleware binding loose ecosystems long enough for specific transactions to close. Many employees do not just run side-gigs—they often leverage the firm itself to power these side gigs, making moonlighting a much more complex phenomenon. Another apt biological metaphor is that of microflora or microbiota strengthening the immune capacity of organisms. Loose colonies and communes of informal microenterprises are thus giving African firms new boosts of vibrancy.

One merely needs to look at the advertising industry on the continent to see what is possible. Rather than a dominance of corporate-style agencies, a cornucopia of freelancers, one-woman firms, entertainment agents, corporate buyers, and a massive diversity of actors are loosely but stickily interweaving and coupling themselves into creative-collaboration complexes capable of delivering good value within tight budgets.

Nowhere is the microflora/microbiota theme more poignant today than in this new advertising environment, where a blossoming of micro-influencers now have traditional agencies under serious pressure. 

As agencies struggle to retain talent and hold on to retainers, they are finding that they need themselves to rethink how they partner with informal enablers.

Kenya built an advertising industry more than four times the size of Nigeria's (despite an economy four times smaller) on the back of strong and fertile ecosystem collaboration among small-time creatives and more corporate agencies, but even Kenya is finding that it needs to double down on innovation as digital intensifies.

In the same vein, one can also observe the Alibaba industrialists shipping knockdowns, inputs, and portable factory lines from China to Africa to kickstart a micro-industrialisation trend that has seen manufacturing growth outpace services for the first time in decades in places like Ghana and Uganda, and take note of how their ecosystems tend to be characterised by informality. (My recent blog on Africa’s unsung industrial revolution explores this in more depth.)

It is more likely that the more productive zones of the informal sector can grow to envelop the teeming masses in the subsistence, productivity-stagnant zones than it is that the formal sector will expand to retrain and redeploy those masses. Forward-looking government policies—like in Tanzania, where procurement is being redesigned to better accommodate associations of informal construction workers, or in India, with rickshaw drivers—may well be the catalysts needed to scale the efforts of hustlers and rainmakers into even larger-scale economic activity. In Ghana, it is not car dealerships and the remnants of the country’s moribund car assembly plants that rallied car mechanics together in an attempt to forestall obsolescence in an automobile industry increasingly being reshaped by electronics. It was freelancing consultants and such mavens who put together SMIDO to do this.

It is important to always bear in mind that real lives are at stake here. Beneficiaries of successful intermediation of informal production systems don’t come more real than the hardworking women of rural Bangladesh.


CGD blog posts reflect the views of the authors drawing on prior research and experience in their areas of expertise. CGD does not take institutional positions.