Tuesday, October 19, 2010

Household enterprises. Are they really that different?

There is increasing consensus on viewing informal enterprises in developing countries as operating on the basis of a cost-benefit decision: to go formal and reap the potential benefits of economies of scale, access to credit, legal protection, access to government procurement and access to government sponsored assistance programmes; or stay informal thus avoiding the costs associated with registration, licensing and taxes (and potentially also hiding from a predatory bureaucracy). The general idea is that the decision is the outcome of weighing up these costs and benefits along with the likelihood of being caught, of being punished if caught, and the scale of the punishment if caught and punished.

First off, this assumes firm managers know of their obligations as enterprises  in the first place. Further, if the benefits are deemed pretty minimal (i.e. poor legal enforcement even for formal firms, not much opportunity for economies of scale given the size of the reachable market etc) and the enforcement mechanisms weak, then you're more likely to get lots of informality.

At the household (HH) level, there is an argument that micro firms (or nano?) are just the bottom end of the size spectrum, an observation based on Latin American experience (by Maloney, Fajnzylber and others in a number of papers). However, those who are more in touch with these household enterprises (HEs) in SSA suggest that they are very different and not enterprises as such. More just survivalist activities with no potential for expansion at all.

Still, the framework would seem to fit. For very small firms (like one-man firms), the benefits to formality are likely to be miniscule compared to the costs, while the balance is likely to shift towards greater benefits from fomrality as the firm increases in size towards some kind of size threshold (something I actually examined in my PhD thesis using manufacturing enterprises data).  Even regarding the knowledge, you could assume that if it was beneficial, the individuals would hear about it and find out themselves about formalising.

However, even if the framework seems to fit, where does that leave us in terms of any policy implications? It doesn’t necessarily imply that business environment reforms (reducing the costs of formal registration, for example) would have any effect – being a one-man band would require some pretty simple requirements to make it worthwhile for anyone, especially if enforcement is weak and the benefits pretty negligible (apart, perhaps, from avoiding hassle). Maybe only when the public goods provided by government (legal recourse etc) become dependable and valuable (and excludable) for formal firms will you get any change.

Whose interest is it in to encourage more formality anyway if they end up being less productive (as some studies suggest)? Perhaps to get people in the system so that if they DO expand then they do so within the system? That might work for some but it seems a pretty broad assumption....

These thoughts were provoked by my reading a Ugandan household survey report, and a paper by Zinnes on Informality and Business Environment Reforms (IRIS, 2009).


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