Should competition agencies care about the informal sector?

Editor's Note: Rita Ramalho is a Program Manager for Enterprise Analysis.

Actually, yes. Informal firms can operate in the same product or geographic markets as formal firms and therefore affect the competition level. So what can competition agencies do to address the informal sector?

The OECD recently held a forum on competition that gathered delegates from over 100 competition agencies. One of the sessions had the purpose of increasing knowledge about the role of the informal sector for competition.

First, can informality be good for competition? On one hand unregistered firms may be unfair competitors to the formally registered companies because informal firms can gain price advantage by not paying taxes and not complying with regulations. Here the competition agencies have very limited power, since the enforcement of these regulations is often outside their jurisdiction. Addressing these non-compliances are normally the job of tax authorities and other regulation agencies.

On the other hand, informal firms can increase the degree of competition in a market by reducing the market share of formal firms. Competition agencies are in fact taking into account informal firms when computing market shares. The challenge in this case is to measure the market share of informal firms. Competition agencies are being creative about it. For instance, in Bulgaria the competition agency uses the purchases of cement (i.e., the main input of the industry being analyzed) to assess the market share of informal firms in the ready-mix concrete market.

Second, are informal firms subject to uncompetitive practices? In some cases yes. Informal firms tend to be small with limited market power. These firms often sell to formal ones that can be large players in the market, which can give them monopsony power. Since the sellers are not registered firms, the competition agencies have limited power to defend them again buyers with market power. 

Competition agencies need to take into account the informal sector when assessing market concentration. However, the informal sector is only a second best solution for increasing competition. Ideally, competition should be increased through formal firms that tend to be more productive, provide better quality products to consumers and give better benefits to workers. Doing Business reforms that promote formalization can also have a role in increasing fair competition.