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More on the benefits of formalization

Mohammad Amin gave us a post on new results from a survey of informal firms. Good data from informal firms is indeed an exciting innovation.

I want to focus on his results from Côte d'Ivoire. It turns out that 95% of informal firms in Côte d'Ivoire believe that their access to credit would improve if they became formal firms. This result prompts Mohammad to ask “why don’t firms register then?”

I wanted to take a shot at answering. First, what does access to finance look like in the formal sector? I did a quick analysis using the custom query tool from the Enterprise Surveys web site.

Only 11% of formal firms in Côte d'Ivoire have a line of credit or a loan from a financial institution. A staggering 66% of formal firms identify access to finance as a major constraint. It doesn’t look like access to finance in the formal sector is very good. Not surprisingly, Côte d'Ivoire also fairs quite poorly in the Getting Credit indicator of Doing Business.

So how do we reconcile all of this information? I’m inclined to believe the informal guys and suppose that access to finance would improve with formalization. But based on what the formal guys say and what the Doing Business rankings say, I bet that the improvement in access to finance would be small. If Côte d'Ivoire improved its business climate, particularly in the area of Getting Credit, many of these informal firms might decide that becoming formal is a good idea.

Comments

You are on an interesting track but there seems to be a disconnect between what the results show and what you conclude. The results show that informal companies have a mistaken perception in Cote d'Ivoire. There actually is no benefit to formalisation for access to finance. Yes, an improved business climate might be cultivated, perhaps by better creditor protection laws...not by Company law or touting the benefits of formalisation.

Submitted by Jonathan Banco on
I think each of these concerns are valid, but the real question is, why are formal firms having such problems accessing capital (i.e why is the Getting Credit rating so poor in the Doing Business Ranking)? I'm not sure what the finance situation in Cote d'Ivoire is but I'm sure interest rates for domestic borrowing are extremely high and therefore prohibitive for even formal firms. Policies must be in place that make business investment less risky, which should aid in lowering rates for domestic borrowing.

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