Supporting informal businesses amid COVID-19 without formalization

This blog is Part II in a two-part series on informality and investment climate. 
Part I—Out of the shadows: Unlocking the economic potential of informal businesses.

Informal firms are facing especially high risks during the COVID-19 outbreak. These businesses are mostly concentrated in the services sector (Figure 1a), which was the hardest hit by the widespread shutdowns imposed to control the spread of the virus (Figure 1b). Given their smaller average size and lower productivity, informal firms are often less able to weather shocks than formal enterprises. They also have less access to finance and government support. Owners of informal businesses—who are disproportionately women in developing countries—often find themselves without social protection. 
 

Figure 1. Informal businesses are vulnerable to COVID shocks

Most relief measures implemented to mitigate the economic impact of COVID-19 primarily benefit formal firms, which are more easily identifiable. Other forms of support, such as liquidity injections through soft loans from financial institutions, help formal firms disproportionately because informal firms are often unable to access credit from formal banks—even in good economic times. And while employment-cost support, tax relief, and easing enforcement of regulations may help many businesses, they are less relevant to informal firms, which may not comply with payroll, taxation, and other business regulations in the first place. 

Yet, ensuring that support reaches informal firms is critical.  Regardless of governments’ long-term stances on informality, failing to support informal firms during the crisis would exacerbate the economic distress that millions of people already face. In addition to supporting otherwise viable formal firms to get through liquidity crises—so they do not go out of business and become informal—helping informal businesses can help speed up recovery. For example, in the aftermath of the December 2004 tsunami, micro enterprises that received grants saw their profit levels recover substantially faster than those that did not.  

Low-cost and no-regret investment climate measures 

Crises are not the best occasions to encourage formalization. Viable formal businesses are being shuttered, leaving the informal economy as the sole lifeline for many.  Globally, COVID-19 has led to the equivalent of 400 million job losses in the second quarter of 2020. Recovery has been limited in recent months, and roughly 15 percent of small and medium-sized businesses and over 30 percent of micro businesses remained closed as of September 2020. 

Figure 2. Business closure rates remain high 

At the same time, in most developing countries, the fiscal space is already constrained, and government capacity to design and deliver effective support programs to businesses is limited. The World Bank’s COVID-19 Business Pulse Survey shows that only 7 percent of firms have received any type of public support in low-income countries during May-August 2020. 

As this crisis continues, governments may want to consider low-cost and no-regret investment climate measures to support informal firms.  They should address aspects of informality that generate specific vulnerabilities due to the pandemic, while avoiding additional burdens on informal businesses. Efforts to reach out to informal firms during this period should not aim at formalization and expanding the tax base. Rather, they should take interim steps towards identifying informal businesses and their employees so they can get access to social safety nets and benefit from government support.  

Possible measures include: 

1. De-linking support and full formalization: Instead of providing public support to firms only in return for their formalization, governments could temporarily ease efforts to curtail informal financing, expand microcredit, provide managerial training to informal firms, and extend social protections to informal workers. For example, Cote d’Ivoire has allocated 150 billion CFA francs ($275 million) to its Support Fund providing grants to informal firms, while unemployment benefits have been extended to workers in the informal sector in North Macedonia, Lesotho, and Vietnam. Alternatively, governments could implement partial registration of informal firms to facilitate the delivery of support without tying registration, tax, or other regulatory compliance. 
2. Leveraging clusters, business associations, and NGOs for support delivery: Governments and donors may promote the formation and strengthening of clusters, business associations, and non-governmental organizations to organize and represent the interests of informal firms. In turn, these partners can become focal points through which to deliver public services and support. For example, the Self-Employed Women’s Association is providing supplies such as masks and training to expand reach to informal entrepreneurs in India. In the long run, clustering may also promote deeper linkages and higher productivity growth among informal firms. 
3. Improving the enabling environment for digital solutions: In addition to leveraging digital solutions to deliver direct support, such as cash transfers, governments could tweak regulations to reduce frictions related to digital transactions—which may gain increased importance amid lockdowns. Countries such as Egypt and Senegal have simplified Know Your Customer requirements for mobile money, while Kenya has introduced a no-charge policy for mobile money transactions below a certain threshold. Governments could also introduce subsidies for mobile phone calls and internet access or training on digital tools. 
4. Channeling support through large firms to benefit informal suppliers: Because of supply-chain linkages, the pandemic’s impact on formal businesses can have knock-on effects on informal companies, such as cancelled orders or delayed payments. Governments could explore making support conditional on passing on the benefits to informal supply-chain partners (for example, commitments to maintain procurement). They could also channel assistance to large firms through facilities that are explicitly designed to support suppliers, including smaller and informal firms. For example, the Emirates Development Bank—in conjunction with IFC and the United Arab Emirates government—has recently launched the National Supply Chain Finance Platform, which currently offers payables finance solutions. 

Later, as countries shift toward economic reactivation and recovery, governments should refocus their efforts to help informal firms open new businesses and expand jobs in the formal sector, while revisiting the deep causes of informality. Reducing regulatory burdens and complexity could encourage firms toward formalization. In turn, facilitating new (and possibly more productive) firms to formalize may lead to more efficient resource allocation, aiding economic recovery in a post-pandemic world.