Understanding and addressing the issue of “informality” is crucial as governments in the MENA region move away from universal subsidies and public sector job creation, historically a foundation of the social contract. High informality raises several problems, including:
- Limited social protection: A significant portion of workers and households without access to social insurance reduces the efficiency and inequality-reducing power of social protection systems.
- Productivity and growth constraints: Informal employment is highly concentrated in small firms, which can hinder economies of scale, productivity, and economic growth.
- Fiscal limitations: Fewer government revenues are collected to deliver public goods and services.
- Structural challenges: Informality reflects deeper structural challenges in an economy, slowing growth and making it less equitable.
Informality does not have to be inevitable. Our new report Informality and Inclusive Growth in the Middle East and North Africa focuses on Egypt, Morocco, and Tunisia where they respectively informal employment rates of 62.5% , 77.3%, and 43.9%, higher than most other MENA countries. The nature of informality in Tunisia is very different from Egypt, and Morocco lays out somewhere in the middle. The three countries have very different legal and institutional frameworks and economies, and different factors contributing to informality. As whole they provide us with a good perspective of the situation of informality across the region.
Our report uncovers evidence that informality does not have to be inevitable: rather it is largely the result of legal, regulatory, and institutional issues. Several factors combine to determine the level of informality including the design of social insurance, legal, and tax systems/burdens, enforcement of laws and regulations, business registration processes, resolution of commercial disputes, credit access, corruption, and unfair competition.
For MENA, our report finds two main areas of institutional weakness:
- Inadequate social protection systems: The current design of social protection systems in the MENA region offers limited coverage and redistribution, particularly in relation to health and old age. This— combined with factors such as minimum wage laws, complex dismissal procedures, and weak labor regulations enforcement—encourages informality and hinders productivity growth.
- Tax “regimes” and enforcement: The tax regime refers to the set of laws, regulations, and institutions governing the estimation and application of taxes. Special tax regimes for some firms, loopholes, and exemptions favor some businesses at the expense of others in MENA, impeding firm expansion, productivity growth, and formal job creation, especially when tax enforcement is weak. The lack of benefits associated with business registration also discourages firms from operating formally, thereby limiting formal employment opportunities.
To address informality and achieve higher, more inclusive growth, MENA governments should start with a policy shift toward a social protection system that gives all citizens access to basic health services and at least a minimum income in old age. Countries should eliminate unfair special tax treatment for some firms, while promoting creation and growth of highly productive businesses. Governments need to have a clear vision and develop a comprehensive set of policies and reforms that align with, and progressively move towards, addressing informality and inclusivity.
The key elements of a roadmap to take on informality include:
- Coordinated reforms: Establishing cross-ministerial implementation groups to ensure a holistic and coordinated approach to policy changes.
- Tailored social protection reforms: Introducing gradual reforms to the social protection system including expanding health coverage to all citizens, transforming the pension system to provide benefits based on contributions paid only by employees and complemented with a non-contributory universal pension and a poverty-targeted cash transfer program.
- Increasing the government revenue: carefully updating the tax code to make it more progressive to attain social inclusive goals, such as taxing environmentally unfriendly activities; abolishing special tax regimes and VAT exemptions; removing regressive universal consumption subsidies, particularly on energy products from which the rich are more likely to benefit; and strengthening tax enforcement.
- Improving basic service delivery: Enhancing the supply of healthcare and public services to increase trust and compliance with income taxes, leading to increased revenues and investments and reduced inequality.
- Private sector reforms: Making job stability regulations more flexible, simplifying business registration, and improving benefits available to registered firms to enhance market conditions, promote formal employment, and increase productivity.