How do enterprises become 'formal'?

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A small brewer in Sierra Leone finds the only way he can compete with cheaper imported beers is by evading sales tax. He'd like to go legitimate but calculates that it would put him of business. Meanwhile, in Brazil, an auto-parts manufacturer would like to get a bank loan to expand but finds that doing so requires an external audit. Because the company has been hiding half its workers from the social security authorities for the last five years, this presents a problem.

Many of us live in a world of regular paychecks, paid holidays, fixed working hours and – unfortunately – annual income tax returns. This has its drawbacks, but it also gives us a sense of security and order without which it would be difficult to plan our lives. It also gives us a feeling of legitimacy and inclusion, albeit at a price, and means we have access to public education, social security, medical care and other services.

Things weren't always this way. Even now, developed countries have large pockets of 'informality' – think of migrant workers in the United States. And informality is even more prevalent in developing countries. Our best estimates suggest that over 30 percent of output and 70 percent of workers in developing countries are to some degree outside the scope of government regulation. Most people also agree the proportion is rising over time.

If there's anything the last two centuries of economy history have taught us, it's that states are indispensable for making markets and public services work on a large scale. But this doesn't mean that all viable states will look the way they do in Europe and the United States. We need to uncover ways of making existing institutions in developing countries perform the same functions they do in developed countries.

How does this process occur in practice? Is changing laws and regulations enough, or are we talking about something more fundamental? How can policy-makers contribute? Please add your comments below and join the debate...

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