What prevents informal firms from becoming formal?

An earlier post on this blog talked about the benefits to informal or unregistered firms from registering. Using data on informal firms in Côte d’Ivoire, Madagascar and Mauritius (Enterprise Surveys), I argued that a majority of the informal firms believe that registration brings real benefits, especially those associated with better access to finance and markets.

The question that arises then is why don’t firms register? Clearly, there must be some costs or impediments to registering and these costs outweigh the expected gains to firms from registering. I discuss below the sorts of costs that the informal firms associate with becoming formal.

The Enterprise Surveys project asked firms about the problems they faced in getting registered. These problems are listed in the table below, along with the percentage of firms that consider them major or very severe obstacles to registering. The listed problems are indeed an obstacle to registering for a large number of firms - especially registration fees and taxes that registered firms have to pay. There are some differences across countries, with firms in Mauritius relatively less concerned about these obstacles and firms in Côte d’Ivoire particularly concerned about bribe payments following registration.

Firms were also asked which among the listed obstacles is most severe. The figure below shows the distribution for the full sample. Avoiding taxes is the expectedly most important but the surprise is that it is very closely followed by the difficulty in getting information on registration procedures.

An interesting side note here is that while getting information is the second highest ranked problem, only 29.7% of the firms consider it to be a serious obstacle (see table above). The implication is that availability of information affects relatively few firms but the affected ones are very seriously affected.

The data confirm this. For instance, over 51% of the firms that report the obstacle as major or very severe also rank getting information as the most important obstacle. The comparable figure for the remaining firms is only 17%. This 34 percentage point jump is much higher than what we find for the other listed problems such as registration fees (27 percentage points), taxes on registered businesses (20 percentage points) and less than 10 percentage points for the remaining problems.

These findings show that informal firms perceive real costs from registering and some of these perceived costs (such as paying taxes and getting information on registration procedures) are indeed pervasive. This raises two important questions for future research. Are these perceived costs holding firms from becoming formal despite the perceived benefits from registering? And how accurate are firms’ perceptions of the cost of registering?