The Impact of Globalization on the Informal Sector in Africa

The Impact of Globalization on the Informal Sector in Africa

Dr Sher Verick

Economic and Social Policy Division,

United Nations Economic Commission for Africa (ECA)

And Institute for the Study of Labor (IZA)

Contact details:

PO Box 3005, Addis Ababa, Ethiopia

Tel: +251 11 544 3144

Email: sverick@uneca.org

Abstract

Contrary to the expectations of much of the early development literature, the informal sector has not only persisted but actually grown in many developing countries, particularly in Africa where it dominates the economy both in terms of output and employment. This growth has occurred in conjunction with increasing globalization and opening up of economies, which has provoked a debate about the impact of these processes on the informal sector. In this debate it is often argued that the poor, usually women, lose out in a globalized world as multinationals seek to exploit low labour costs in developing countries. The empirical evidence suggests that there are in fact both winners and losers in a globalized economy. Given the importance of informalization in African economies, this paper sets out to summarise the nature of the informal sector in Africa and how globalization affects its development. Based on the issues discussed in the paper, a number of policy recommendations are proposed. The ultimate aim of any African government must be job creation and poverty alleviation, and the policy response for this objective has to address both the removal of the barriers that constrain the participation of enterprises and workers in the formal economy, as well as extending assistance to those in the informal sector. However, this poses a particular challenge for policymakers, namely the trade-off between the ability of the sector to generate jobs and the level of benefits and protection provided for informal workers.

Keywords: globalization, labour markets, informal sector, Africa

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1. Introduction

Globalization through trade, foreign direct investment (FDI), capital, technology and migration flows can stimulate demand and productivity, resulting in higher incomes and job creation, and hence, a reduction in poverty. Using cross-country data, most of the empirical evidence presented during the 1990s indicated that openness to trade has a positive effect on economic growth (see, for example, Winters (2004) and the references quoted therein). In addition to other factors, this implies that the labour market plays an essential role in the link between globalization, growth and poverty. However, understanding these linkages has proven to be challenging in both theoretical and empirical terms.

For some decades the Stopler-Samuelson theorem, one of the central results of the Heckscher-Ohlin (HO) model of trade, has provided a theoretical framework that explains how trade impacts employment and wages. The basic prediction of this model is that trade liberalisation leads to an increase in demand for labour-intensive goods produced in developing countries (conversely, an increase in the demand for capital-intensive goods in the developed world). This subsequently pushes up the real return to labour (wages) and decreases the return to capital. In most developing countries the abundant factor is unskilled labour, and therefore, trade liberalisation is expected to increase the returns to these workers, leading to a reduction in inequality. These predictions, however, rely on a set of strict assumptions, and once any of these often-unrealistic theoretical conjectures are dropped, the predictions of the theorem become more ambiguous.

In the African context these predictions are especially incongruous with the structure and characteristics of the labour market. One of the most important characteristics of the labour market in Africa is the prevalence of informal employment, which according to some figures now accounts for 72 percent of non-agriculture employment in sub-Saharan Africa, 78 percent if South Africa is excluded (ILO 2002c). Other studies claim that a vast majority of jobs created in the 1990s were outside the formal sector.

Lewis (1954) proposed a theoretical model of economic development where there is an unlimited supply of labour in the informal sector or in subsistence agriculture. The model implies that as the formal sector develops, its demand for labour increases, absorbing this excess labour, which subsequently leads to a shrinking informal sector. The Lewis model dominated the development discourse during the 1950s and 1960s as Europe and Japan rebuilt their economies (Chen et al. 2002). However, in recent decades, the growth of the informal sector in developing countries has precipitated a rethinking of its role in the economy, particularly by the International Labour Organisation (ILO) in the early 1970s. The main question raised by these explorations is why did informal employment not only continue to exist but actually grow, while the formal sector declined? What role did globalization have in this process?

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Another issue is that the informal sector by definition does not provide the same benefits and protection to workers and businesses as found in the formal economy. Therefore, since the informal sector has been growing in recent decades in Africa, this suggests that there is a potential trade-off between job creation and employment conditions. This is a particular challenge for policymakers who strive on the one hand to promote economic growth and job creation, and at the same time improve the situation of workers in Africa. This challenge raises a number of questions: should African governments aim to integrate the informal sector into the formal economy in order to extend benefits to this sector, though this may hamper growth and job creation?; or should they instead focus on deregulating the formal sector to remove the barriers to workers and enterprises from participating in the formal segment of the economy?

Little is known, however, about the effects of globalization on the informal economy and how changes in trade and FDI affect employment in this sector. For this reason, the main contribution of this paper is furthering our understanding of the informal sector in African countries and the effects of globalization on this aspect of the labour market. The paper consists of two parts. The first part is made up of two sections (Sections 2 and 3) covering the conceptual and theoretical background in addition to the empirical evidence. In Section 2 we review the trends and the characteristics of the informal sector in Africa. Section 3 goes into more detail about the relationship between globalization, particularly trade, and the informalization of the economy. The second part of this paper (Section 4) addresses these issues in terms of policy recommendations.

2. Trends in the Africa informal sector

Following the current conceptualisation, this paper restricts the informal sector to the urban context. ILO (2002a) provides a more detailed discussion on the interaction between the status of the enterprise and employment, resulting in a number of different variations of informalization in the economy. Since many African countries either don't collect data on the informal sector or they use different definitions, it is difficult to make strict comparisons within and between countries. Nonetheless, the available data clearly indicates that the informal sector represents both a significant component of gross domestic product and employment in most African countries.

The World Bank as part of its work on benchmarking business regulations has developed a measure of the size of the informal economy. The methodology for estimating this indicator is based on the study by Schneider (2002). Using this data, Figure 1 graphs the size of the informal economy as a percentage of gross national income (GNI), which ranges from under 30 percent in South Africa, the continent's largest economy, to almost 60 percent in Nigeria, Tanzania and Zimbabwe. The average in sub-Saharan Africa (SSA) is 42.3 percent.

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Figure 1 – Size of the informal sector in sub-Saharan Africa (ratio of GNI in 2003)

010203040506070SSA averageBeninBotswanaBurkina FasoCameroonCote d'IvoireEthiopiaGhanaKenyaMadagascarMalawiMaliMozambiqueNigerNigeriaSenegalSouth AfricaTanzaniaUgandaZambiaZimbabwePercent of GNI

Source: World Bank Doing Business database. This indicator measures output in the informal economy as a share of gross national product (%GNP, 1999/2000) sourced from the study by Schneider (2002)

Turning to the labour market, based on figures reported in ILO (2002a) the informal sector in SSA is estimated to represent around three-quarters of non-agricultural employment. According to ILO (2002c), the sector amounts to 72 percent of employment in sub-Saharan Africa, 78 percent if South Africa is excluded. Statistics reported in Chen (2001) suggest that 93 percent of new jobs created in Africa during the 1990s were in the informal sector, reflecting the impact of globalization, economic reforms and competitive pressures on the labour market in recent years.

Xaba et al. (2002) summarises the experience of a number of African countries, which shows that there has been a decline or stagnation in employment growth in the formal sector, while the informal sector on the continent has been growing in terms of both its share of output and employment. For example, informal employment in Kenya and Uganda exceeds employment in the formal sector. In terms of Southern Africa, in Zambia 43 percent of urban employment is in the informal economy, while in Mozambique evidence suggests that 30-40 percent of urban households were dependent on the informal economy in the 1990s. As also reported in Xaba et al. (ibid), 89 percent of the labour force in Ghana is employed in the informal sector.

ILO (2002b) reports on the share of employment in the informal sector for a number of African countries based on the harmonised and national definitions.1 Figure 2 presents the share of total employment in the informal sector using the national definition for a

1 The differences in the definitions do have a considerable impact on the final aggregate statistic. For example, 50.2 percent of total employment in Ethiopia is in the formal sector according to the harmonised definition, while the national definition suggests a much higher share of 74.2 percent.

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number of African countries. Though the figures are for different years, it is clear that the share of informal employment varies considerably within Africa, ranging from 8.8 percent in Zimbabwe to 94.1 percent in Mali.2

Figure 2 – Share of total employment in the informal sector

0102030405060708090100Botswana (1996)Ethiopia (1999)Ghana (1997)Mali (1996)South Africa (2001)Tanzania (1991)Zimbabwe (1987)Percent

Source: ILO (2002b)

The informal sector in Africa is dominated by trade-related activities, with services and manufacturing accounting for only a small percentage of this sector (UN 1996). For example, in Angola, Nigeria, South Africa and Uganda, a majority of informal sector workers are active in retail trade (ILO 2002a). Most of these workers are self-employed, which accounts for 70 percent of workers in this sector in SSA, with the remainder in wage employment (ILO 2002c). Street vending is one particular informal activity that is prevalent on the continent. According to 1992 figures quoted in Charmes (1998a), street vendors represented 80.7 percent of all economic units surveyed in urban areas in Benin, with women making up over 75 percent of vendors.

Characteristics of informal employment

Informal employment in developing regions such as Africa is characterised by a number of traits (see, for example, Vishwanath (2001) and Avirgan et al. (2005)). Besides the high proportion of women and self-employment, there are also a number of other defining characteristics of informal workers in terms of education levels, wages (and hence, poverty), hours worked and overall employment conditions. In particular, informal employment is characterised by the lack of decent work or deficits in comparison with employment in the formal segment of the economy.

2 The share for Zimbabwe has increased in recent years as a result of economic stagnation, which is reflected in Figure 1.

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Firstly, workers have lower levels of education and rates of literacy compared with the formal sector, reflecting that poor human capital increases the probability of participation in the informal sector. As reported in Braude (2005), there is a stark difference in the education levels of workers in the South African informal and formal sectors – 37 percent of workers in the informal economy in South Africa have not completed primary school education compared to only 16 percent for the formal sector. Related to low education is the phenomenon of skill mismatch, which occurs when job seekers lack the skills demanded by employers. This problem is evident in the urban labour markets of many African countries where school leavers seek a job in the public sector, but as a consequence of downsizing and retrenchments, there are few opportunities. At the same time, these youths do not have appropriate skills for other forms of formal sector employment in industry or service activities (the mismatch). These youths, therefore, end up unemployed or working in the informal sector, with many of them still "queuing" or waiting for a job in the public sector.

Secondly, given that wages are usually much lower in the informal sector, rates of poverty are subsequently higher amongst workers and families who rely on informal employment. According to the ILO, wages are on average 44 percent lower in the informal sector (ILO 2002a). El Mahdi and Amer (2005) find that informal workers in Egypt earn approximately 84 percent on average of what workers receive in the formal sector. Similar results were also found for South Africa (Braude 2005). However, such estimates do not control for occupation, which has been found in the gender wage gap literature to have a large impact on the disparity between female and male wages.

Thirdly, informal sector workers typically work longer hours in the week; results for Egypt suggest that the average number of hours worked in the informal economy was 51.6 in 1998, while it was only 44.6 in the formal segment of the economy (El Mahdi and Amer 2005). Other decent work deficits that are more prominent in the informal economy vis-à-vis the formal sector include poor health and safety, high job insecurity, no worker representation and few opportunities for skill enhancement (ILO 2002a). Finally, child labour is a persistent problem in the African informal sector, an issue addressed in Xaba et al. (2002).

Characteristics of enterprises in the informal sector

Looking at the enterprise side, there are also a number of defining features, which characterise these businesses in Africa (see Becker (2004)). These include:

♦ There are low set up costs and entry requirements, which are presented above as key factors behind informalization.

♦ Operations are typically on a small scale with only a few workers.

♦ Skills required for the business activities are usually gained outside formal education.

♦ The production of goods and services is labour intensive.

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Again turning to the Doing Business Database compiled by the World Bank, it is interesting to consider the heterogeneity in some of the key business factors behind the development of the sector in Africa. The database contains figures for various indicators representing the ease of starting up a business, hiring and firing workers, registering property, getting credit, protecting investors, enforcing contracts, licensing requirements and closing a business.3 For example, based on certain assumptions regarding the nature and location of the business, sub-Saharan enterprises are required to complete 11 procedures on average in order to establish a new business, the equal highest amongst all regions. This process takes over 63 days in sub-Saharan Africa, the longest of any region. The cost of starting a business in SSA represents 215.3 percent of GNI per capita, which is over three times higher than the next most expensive region (Middle East and North Africa). This figure, however, masks the heterogeneity in SSA: the percentage ranges in fact from 8.6 percent of per capita GNI in South Africa to 1,442.5 percent in Zimbabwe. Overall, these figures show that establishing a business in the formal sector in SSA is a complex, lengthy and costly undertaking, which are all reasons for enterprises to remain informal.

Another barrier for enterprises to operate in the formal economy is licensing. In sub-Saharan Africa there are on average 20.1 licensing procedures for a business in the construction industry to build a standardized warehouse. These procedures include obtaining licenses and permits, completing notifications, inspections and submitting the necessary documents (see www.doingbusiness.org). The figure for SSA varies from 11 in Kenya and Namibia to 48 in Sierra Leone. The only region that has more licensing procedures than SSA is Europe and Central Asia (21.4). These procedures take approximately 251.8 days in sub-Saharan Africa, ranging from 127 in Ghana to 569 in Cote d'Ivoire. On average the cost of registration amounts to 1,597.3 percent of GNI per capita, with a minimum in Mauritius of 16.7 percent and maximum of over 10,000 percent for Burundi. This cost illustrates another barrier enterprises face when undertaking such an investment.

The different dimensions covered by the World Bank's Doing Business database allows for a more detailed empirical country-level analysis of the most important factors determining the size of the informal economy. A first look at the correlations between the size variable and other characteristics reveals that the following factors are positively and significantly correlated with the size of the informal economy: time to get a license; cost of registering a property; and the number of documents required for exporting. The relationship between the size and the cost of property registration is illustrated in Figure 3 above. This graph shows that an increase in the cost of registration by 1 percentage point is associated with an increase in the size of the informal economy by 0.6 of a percentage point. While there are many potential variables that influence the formation and growth of the informal economy, this preliminary analysis indicates that these barriers and costs to doing business are important factors behind this phenomenon.

3 See the World Bank's Doing Business website and online database: www.doingbusiness.org

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Figure 3 – The relationship between the size of the informal economy and the costs of setting up a business in Africa

010203040506070051015202530Cost of registering propertySize of informal economy

Notes: The size of the informal economy is the percentage of this sector in terms of gross national income (GNI) (as of 2003). The cost of registering property is stated as a percentage of the property value (as of January 2005).

Source: World Bank Doing Business Database (www.doingbusiness.org)

Gender dimensions of the African informal sector

An important aspect of informalization is the significant representation of women in informal employment in Africa, where most women are normally self-employed or unpaid home-based workers (Chen 2001). Figures presented in Charmes (1998b), which are reproduced in Table 1, illustrate the important role of women in informal activities in Africa. According to these statistics, the share of women in total non-agricultural informal employment ranges from 5.0 percent in Tunisia, which is the result of the traditional role of women in this country and their low labour force participation rate (around 27 percent in Tunisia (1997)), to 71.9 percent in Mali. In informal trade, the share in employment is even higher, reaching 92.2 percent in Benin and 81.3 percent in Mali. The highest share in informal industrial employment amongst these selected countries is 88.5 percent in Burkina Faso. Participation of women in the informal service sector is not so evident with the share only reaching 48.5 percent of employment in Mali.

In terms of aggregate output in the informal segment, it is estimated that the contribution of women is larger on average than of men, except for Tunisia where it accounts for a minor 3.2 percent of informal sector GDP. These percentages reveal that though women clearly play a dominant role in the African informal sector, there is also considerable heterogeneity in terms of sectors and countries.

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Table 1 – The role of women in informal employment in selected African countries Indicator	Benin (1992)	Mali (1989)	Chad (1993)	Burkina Faso (1992)	Tunisia (1994-1996)
Share of informal employment (%)
Total non-agricultural	59.7	71.9	53.4	41.9	5.0
Industry	42.8	73.2	24.5	88.5	4.4
Trade	92.2	81.3	61.8	65.9	2.4
Services	20.5	48.5	47.1	10.7	3.6
Contribution to informal sector GDP (%)	51.1	68.2	62.3	61.4	3.2