The Informal Economy is Complicating Government Responses to COVID-19: Will the Crisis Push Millions Toward Formality?
As COVID-19 spreads in countries around the world, governments have already started to address the economic and livelihood challenges posed by the constraints the pandemic has put on behavior and employment. Wealthier OECD countries are designing economic support measures to target the backbone of most economies – the tens of thousands to millions of small businesses. These efforts intend to provide a lifeboat to help businesses survive the coming months, and importantly, to continue to pay their employees as normal economic life slows down at a disastrous pace. The U.S. has a congressional coronavirus relief fund for small businesses. The Australian government has put into place a series of measures that are mostly targeting small and medium enterprises (SMEs) with a turnover of less than $50 million, which include stimulus payments and measures such as a tax credit to boost cash flow for employers. The European Investment Bank announced a €25 billion fund especially aimed at SMEs, with the goal of slowing down job losses.
These measures will help cushion the impact of COVID-19 on employment in wealthier areas. But what about lower-income countries? As a recent Oxfam report noted, 500 million people – largely in developing countries – could be pushed into poverty during this pandemic. And efforts to support the SMEs that drive employment in these countries are complicated by the unique nature of these businesses.
THE CHALLENGES OF INFORMALITY
According to the International Labour Organization, 93% of the world’s informal employment is in emerging countries. In Africa alone, over 85% of employment is informal. Developing nations across Africa are also attempting to provide economic support packages targeting their SMEs, but this informality makes it difficult. Many small businesses – from micro-enterprises which operate as traders, to small restaurant businesses, for example – have no incorporation and no listed employees with bank accounts.
This presents developing nations with a vexing challenge: determining what mechanisms can quickly deploy economic support to these informal businesses and individuals, and what methods can target them effectively. This challenge threatens to reduce the effectiveness of the measures currently being put into place. For instance, in March, Ghana announced a 1 billion cedi stimulus package (~$173 million USD) for households and businesses, particularly SMEs. But it includes measures like extending the tax filing date and reducing the central bank interest rate. That sounds fine for the formalized, but likely won’t mean much to the countless informal enterprises that don’t pay taxes or access formal finance, which comprise the vast majority of the economy.
In many developing nations, there are disincentives for businesses to become formalized, in terms of cost, time and risk. Where there is corruption at many levels of government, weak rule of law, and cumbersome and unclear taxation rules, formality can feel unnecessary – not to mention risky. For many business owners, formalizing their enterprise means paying various random taxes demanded by obscure government offices (while seeing no reliable public benefits) – or being asked to pay a bribe to be left alone.
Further complicating this picture, there is also informality at the individual level: poor and weak identification systems that omit large populations in many emerging countries. According to the 2018 Global ID4D Dataset, an estimated 1 billion people lack a foundational ID, and 50% of them live in Africa. And among those below the national ID age, 47% don’t even have birth registration. This lack of formal ID is greatly complicating efforts to deliver economic relief, in countries around the world.
DIGITAL PAYMENT SYSTEMS IN DEVELOPING NATIONS
Payment systems are the distribution end of financial assistance, and speed and efficiency are of paramount importance in leveraging these systems to address a crisis like COVID-19. Digital payments platforms have proven to be extremely effective in allowing people to buy items and make and receive payments at a distance, without any physical presence or cash – something that is increasingly essential in this age of social distancing. These platforms have begun scaling in many emerging markets, and beyond rapid digital payments, they offer basic account functionality – particularly important in countries where 60-80% of people often do not have a traditional bank account. These digital accounts already serve as a destination for government benefit and income support payments, in countries from Senegal to India.
There has been plenty written about mobile money and digital payments, and how they can be – and need to be – leveraged right now. Yet as the pandemic progresses, gaps and challenges in the payments and banking systems are becoming visible in many countries – often driven by the lack of formal ID and the required Know-Your-Customer registration processes. Without effective identification, payments cannot be effectively targeted or delivered to the individuals or SMEs that need them – and it’s almost impossible to confirm that these payments have reached their intended target. Unless these payment system gaps are addressed, inequality will only be exacerbated, worsening an already-grave economic crisis.
In countries where a huge proportion of small and micro-businesses are informal, direct government-to-person (G2P) transfers will make the biggest impact. During a pandemic when delivery systems are stressed, investing in or fast-tracking digital G2P payment systems can be vital. Governments in these countries are focusing on scaling up payment and account systems that can be provided rapidly at very low cost – including to the informal economy. Even with the large gaps in identification systems, some governments are not hesitating at all in their efforts to quickly deploy economic support to the entire population. For instance, Togo has set up a cash grant designed to support informal workers during the three months of state-mandated social distancing – an unconditional cash transfer grant that gives each worker 30% of the minimum wage. The aim is to help beneficiaries pay for basic daily necessities such as food, sanitation and communication, to cushion them from the full economic impact of COVID-19 distancing. Citizens sign up via mobile phone, and the transfer is delivered by mobile money. Similarly, in Pakistan, poorer citizens may now use their mobile phone to enroll in an emergency support program run by the newly created Ministry of Social Protection and Poverty Alleviation, with payments transferred digitally and linked to biometric identity. And Jeffrey Bower, founder of Bower & Partners, a consulting firm that designed Peru’s interoperable payment switch, reports that the switch is being used to pay a COVID-19 subsidy to 50% of Peruvians.
To expand on these types of initiatives, African governments and their partners need to find mechanisms – or improvise them if necessary – to extend support payments to their populations and small businesses, to help them make it through the COVID-19 crisis. If they don’t, they risk losing the progress their economies have made over the past decade – along with potential threatening outcomes; civil unrest, loss of community trust, and the spread of disease and death.
This article is part of NextBillion’s series “Enterprise in the Time of Coronavirus,” which explores how the business and development sectors are responding to the pandemic. For news updates and analysis, virtual events, and links to useful resources related to the COVID-19 crisis, check out our coronavirus resource page.