MSME formalization: policy recommendations

Given the benefits of business formalization, policymakers must develop policies that encourage MSMEs to formalize their businesses. The recommended policy options are elaborated below:

  • Effective enforcement of regulations requiring the informal business to register 
    Enforcement is critical to ensure compliance with rules and regulations, enabling the attainment of any set objectives. The formalization of business is expected to improve through proper enforcement mechanisms to track and monitor its progress.
  • Match the obligations of formalization with benefits and punish informality 
    Overall, an enforcement mechanism in place is essential, but it should be accompanied by other reforms such as the facilitation of formalization. It should not discourage starting a business and entrepreneurship and ideally integrate a warning mechanism to entrepreneurs with sufficient time before applying the enforcement.
  • Promoting registration through better business environment reform 
    Registration is only a first step towards formalization. Throughout the business life cycle, compliance with other regulations is needed to follow up the process of formalization. An unfavourable, overly complicated and costly business environment might make many micro-enterprises reconsider their registration. Several relevant instruments policymakers can apply to promote the registration of companies that go from facilitation through digitalization to decreasing registration costs.
  • General improvement of the business environment
    A general improvement of the business environment would provide a strong incentive for businesses to be a part of the formal sector. In general, overregulated, complex and costly business regulations reduce the efficiency of the business environment and provide strong incentives to businesses to remain informal.
  • Reducing the costs of business entry and streamlining business registration
    Businesses still consider the process of formalisation as costly, and a reduction in these costs would be perceived as beneficial. However, while considering this, policymakers should also consider that these costs are necessary to ensure excellent and stable registration infrastructure and enable the financial sustainability of institutions working on business registration.
  • Reducing burdens of registration through the digitalisation of the business registration 
    Several countries have digitalized their registration process, allowing companies and individuals to register online and facilitating the process. This enables data gathering and can help share data among various agencies working with the business.
  • Policy instruments on incentive-focused formalization mechanism 
    Policymakers can provide a wide range of incentive mechanisms such as offering better access to finance, public procurement or business development services. Some governments also offer tax breaks for newly registered entities. Pro- formalization-related incentives have proven to be successful in several countries worldwide (USAID, 2007). For example, they are offering better access to finance to registered enterprises when they go formal.
  • Offering access to business development services (BDS) and government support services 
    The ability of firms to increase their productivity while upgrading their technology and innovation capacity is regarded as an essential determinant of competitiveness. Unfortunately, generally, MSMEs have deficient levels of productivity and have very few ways to improve it. Without being formally registered, businesses are typically not in a position to take advantage of services that might be on offer from the government, including business development support, standards compliance assistance and marketing help. Given the quality and traceability requirements, they can neither provide goods and services to the government for procurement nor access regional or international markets. Thus, governments should promote the advantages of formalization to businesses. MSMEs often have limited knowledge of the availability, effectiveness and potential benefits of BDS.
  • Business opportunities, especially accessibility to public procurement after becoming formal 
    The objective of supporting MSMEs and facilitating their access is embedded in most countries' public procurement policies and strategies. This strategic dimension principally promotes using the public sector’s purchasing power to stimulate MSME participation and competition, thus increasing value for money in public procurement.
  • Policy instruments taking advantage of digitalization to facilitate the formalization of micro-enterprises 
    Policymakers could encourage more companies to go digital to become more competitive and enter new market segments. Digitalization can also help companies become more formal. For example, Under the Better for Business initiative (Ministry of Business), New Zealand uses digital technologies to make significant improvements to the business experience. The technology helps make information and regulation more accessible, improves the transparency of government processes, and helps businesses navigate the regulatory and administrative maze. New Zealand also introduced a specialized digital platform called Business Connect to design and deliver consistent and coordinated services across Government.