Describing MSMEs in the informal sector

There are different degrees of informality among enterprises ranging from those who are not registered and escape detection by the public administration (total informality), to those who are registered and are acknowledged by the public administration, but are not fully compliant (partial informality).

Informal MSMEs are mostly those economic establishments owned by one person or a family or fall under a formal definition of micro-enterprises. They are not registered (or loosely registered), not in a formal legal institution, without a well-defined legal status. Thus, they are being considered informal (or quasi-formal). They often employ less than ten employees and rely primarily on family members as workers. They also include non-farm self-employed people who operate as sole proprietors or sole traders but are unregistered or loosely registered (those not fully registered enterprises). For example, micro-enterprises might register with a  provincial office but not with the social security office. It is argued that informal enterprises provide a source of income to vulnerable populations and act as a buffer within an economy lacking formal social security systems.²²² However, for most developing countries, a high level of informality translates as a narrow tax base and yawning gaps for a government that tries to stretch itself bare to provide a minimum health and social security system from the low level of taxes generated from informality.

The informal economy is marked by acute decent work deficits and a disproportionate share of the working poor. Empirical research has shown that workers in the informal economy face higher risks of poverty than those in the formal economy.²²³ As a result of these and other factors, there is a significant, but not complete, overlap between working informally and being poor and vulnerable. While some activities offer reasonable livelihoods and incomes, most people engaged in the informal economy are exposed to inadequate and unsafe working conditions. They have high illiteracy levels, low skill levels and insufficient training opportunities.

Most countries have a sizeable informal economy. A significant share of economic activity across South-East Asia, for example, remains informal. Informal employment is estimated to account for around 75 per cent of the labour force across the subregion²²⁴, though with sizeable differences between countries. Thus, many businesses may be unable to access policy support measures, and many workers, who cannot access social security benefits, are particularly vulnerable to declines in income. The informal economy is also excluded from safety and health, maternity and other labour protection legislation.²²⁵ Gender is also an issue, where women are often found to operate more frequently in the informal sector than men, are more present as migrant workers, and take on a more significant share of household and childcare duties.²²⁶

Why informality matters
The COVID 19 pandemic increases the vulnerability of MSMEs. Lower resilience and flexibility related to their small size makes it more challenging to cover costs for prevention, underutilized labour and capital, adjust work processes, and access necessary technologies and supplies. Furthermore, a drastic decrease in demand and revenue caused by consumers’ loss of income, fear of contagion and heightened uncertainty leads to severe liquidity shortages.²²⁷ MSMEs in sectors such as tourism, hospitality and transportation, have been significantly affected by the pandemic. In light of the COVID-19 outbreak, the formalisation of businesses is becoming increasingly important. MSMEs that stay informal are deprived of crucial assistance during the pandemic, like governmental business support schemes, access to finance, legal protection and social safety nets for the enterprise and its employees. Informality also creates several asymmetries and undesirable outcomes in the economy, such as:

• Lack of a level playing field
  Formalised enterprises are likely facing a higher cost of doing business than informal ones, creating an unfair environment for compliant enterprises.
• A lower level of productivity and competitiveness
  Research has found that overall productivity in informal businesses tends to be lower than that in the formal sector. However, in some cases, digitalisation might help to improve productivity among selected micro-enterprises.
• Lack of access to Government support schemes
  Government support schemes are typically only offered to formalized businesses.
• Difficulty to access finance
  It is more difficult for an informal business to access finance, and rates may be much higher.
• Difficulty to access local and international markets
  Their lack of technical knowledge of the markets and their low compliance with national and international standards hinder these informal enterprises from participating in global value chains.
• Lack of legal protection for the enterprise, its employees, its customers and suppliers
  Informal enterprises seldom enter into any formal contract obligations; hence, they tend to lose out on the legal ground in the event of a dispute.
• Lower government gains
  The government will not tax unregistered enterprises, which may be needed to develop infrastructure, pay for education and ensure essential services.

These are the main reasons why policymakers should lower the level of informality in their countries. Doing so would make their economy more competitive and fair in the medium and long run.