are informal enterprises a drag on productivity in kenya? mehnaz safavian lead financial sector...
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Why do firms choose to remain informal, and what are the benefits to formalization? As firms grow in size, do they stay informal? Do policies to boost formalization work and are they worth the cost to design and implement? Data sourced from -Emerging literature on firm informality -Data collected on formal microenterprises and informal firms as part of the World Bank’s Enterprise Survey initiative for Kenya (http://www.enterprisesurveys.org/)http://www.enterprisesurveys.org/ 2 Key QuestionsTRANSCRIPT
ARE INFORMAL ENTERPRISES A DRAG ON PRODUCTIVITY IN KENYA?
Mehnaz Safavian Lead Financial Sector SpecialistWorld Bank Group, Nairobi
2
Characteristics of the Informal Economy
La Porta and Shliefer (2014) have established 5 themes that characterise the informal sector:
1. Significant size: accounts for around 30-40% of total economic activity across the world’s poorest countries
2. It has extremely low productivity compared to the formal economy
3. Removing traditional hurdles such as tax, registration costs and regulations does not always bring informal firms into the formal sector, as productivity is often too low
4. The informal economy is largely disconnected from the formal economy
5. As countries grow and develop, the formal economy begins to dominate economic life and the informal economy shrinks
Why do firms choose to remain informal, and what are the benefits to formalization?
As firms grow in size, do they stay informal?
Do policies to boost formalization work and are they worth the cost to design and implement?
Data sourced from - Emerging literature on firm informality - Data collected on formal microenterprises and informal firms as part of the World
Bank’s Enterprise Survey initiative for Kenya (http://www.enterprisesurveys.org/)
3
Key Questions
BACKGROUND TO THE KENYAN MARKET
Kenya has the highest proportion of informal to total employment in Africa1
Kenya National Bureau of Statistics estimates that the informal sector represents 82.7% of employment in Kenya as at 2014.
Almost 700,000 jobs were created by the informal sector in 2014 vs. 106,000 in the formal sector, according to the Kenyan Economic Survey for 2015.
In Kenya, more than half of informal sector jobs are in trade, restaurants, and hotels.
41 Based on the United Nations’ Economic Commission for Africa coverage group
5
Key Constraints Faced by the Informal Sector
Recent data collected on informal firms and formalmicroenterprises in Kenya reveals the following constraints:
1. Access to finance
2. Electricity problems
3. Access to land
4. Corruption
59%
10.3%
9.3%
9.3%
6
Access to finance remains the biggest constraint
Source: Enterprise Surveys
Multiple Employee Single Employee
55%
62%
The proportion of firms that consider access to finance their top obstacle is significantly lower as firm-size, measured by the number of employees,
increases
7
Access to finance remains the biggest constraint
Central Nyanza Mombasa Nairobi Nakuru All firms
62%56%
65%60%
51%
59%
3%
21%15%
6%3%
9%
3%0%
13% 14% 12% 9%9%14%
0%7% 4% 6%
20%
5% 3%8%
17%10%
Access to finance Access to land CorruptionCrime Electricity
Perc
enta
ge o
f firm
s
Source: Enterprise Surveys
Regional differences are pronounced
As might be expected, firms that consider access to finance as an obstacle for their current operations are far more common among firms that are financially constrained vs. those that are not (76 vs. 39%, respectively).
Larger, older and more productive firms are less likely to be financially constrained than the rest
8
Over 60% of firms are “financially constrained”
Source: Enterprise Surveys
53%67%
56%
63%
55%
65%
Perc
enta
ge o
f firm
s th
at
are
finan
cial
ly
cons
trai
ned
Labor Productivity Firm Age Revenues
CURRENT FINANCING TRENDS IN THE INFORMAL SECTOR
9
87%
35%
19% 16%9% 9%
Sources of Financing for Informal Firms
A B C
Younger firms more likely to use their own funds
Furniture industry less likely to use their own funds
Central and Mombasa regions more likely to use own funds
10
Use of Internal Funds
Key Trends Firm Age
Industry / Sector Regional Variation
75% 85% 92%
10 Years or Older Younger Than 10 Years
81%
89%
Central Mombasa Nairobi Nakuru Nyanza
98% 94%84% 81% 77%
A
11
Advances and credit from suppliers/customers
Labor Productivity Type of Industry
Firm Dynamism Regional Variation
Below Median Above Median
12%
26%
13%
23%
38%
Did Not Grow Grew in Last 3 Years
14%
33%
Mombasa Other Regions
8%
22%
B
12
Use of banks to finance working capital
Use of bank finance for working capital is more common among firms with more educated owners and among the more productive and large firms (see graph below)
Within firms that use bank finance, 63% report better access to finance as a benefit from registering; the corresponding figure for firms that do not use bank finance is significantly higher at 78%.
3%6%
16%
6%
13%
6%11%
Per
cent
age
of fi
rms
that
use
ba
nks
to fi
nanc
e w
orki
ng c
apita
l
Source: Enterprise Surveys
C
OTHER ASPECTS CHARACTERIZING THE INFORMAL SECTOR
Labor Productivity
Gender Observations
Does the Business Environment Matter?
13
1
2
3
Informal firms are much less productive than formal firms, with productivity calculated as value added per employee
Wages in informal firms are around one half of those in small formal firms and one third of larger firms
On average, human capital (measured by education) differences are small between formal and informal firms, but differences in human capital of management are significant. There are enormous productivity gaps between firms run by educated vs uneducated managers and entrepreneurs
14
Labor Productivity1
Informal Formal Micro
22
190
Mon
thly
sal
es p
er w
orke
r (K
ES
, '00
0)
Labor Productivity of Informal vs. Formal Micro Firms
For the informal firms surveyed in Kenya, the mean value of labor productivity equals KES 22,481. The median value is KES 13,000.
However, there are differences in labor productivity across firm-size, sectors, education level of the manager and regions, as seen below:
15
Labor Productivity
Firm Size Industry / Sector
Manager Education Level Regional VariationServices Other Manufacturing Furniture
21 22
28
More Than 1 Employee Single Employee
22
24
Mombasa Nyanza Nakuru Central Nairobi
17 18 2026
31
No / Primary Secondary Vocational / University
19 2126
Mon
thly
sal
es p
er
wor
ker
(KES
, '00
0)M
onth
ly s
ales
per
w
orke
r (K
ES, '
000)
Mon
thly
sal
es p
er
wor
ker
(KES
, '00
0)M
onth
ly s
ales
per
w
orke
r (K
ES, '
000)
1
Women-owned firms in Africa tend to underperform those owned by men This also holds true for Kenya
16
Gender ObservationsM
onth
ly s
ales
per
wor
ker
(KE
S, '
000)
Informal Formal Micro
25
220
18
94
19%
31%
7%7%
21% 24%
Per
cent
age
of fi
rms
Female managers are more likely to operate from inside household premises, less likely to have a job or be
looking for one in the formal sector than male managers
2
Labor Productivity of Male vs. Female Managers
Informal Formal Micro
18
94Male manager Female manager
Hypothesis: when the business environment is poor, informal and formal firms will be less distinguishable, and conversely, in a higher quality business environment, differences in growth and productivity between formal and informal firms will emerge.
Findings seem to support the hypothesis, based on the same Enterprise Survey data from the World Bank but from 2007-2009
17
Does the Business Environment Matter?
Research based on paper by Gelb, Alan and Mengistae, Taye and Ramachandran , Vijaya and Shah, Manju Kedia, To Formalize or Not to Formalize? Comparisons of Microenterprise Data from Southern and East Africa
DB 2007 DB 2014 Difference
Starting a Business
Procedures (number) 13 10 -3
Time (days) 54 32 -22Cost (% of income per
capita) 46.3 38.2 -8.1
Dealing with Construction Permits
Procedures (number) 6 8 +2
Time (days) 158 125 -33Cost (% of income per
capita) 1 3.4 +2.4
Paying Taxes
Payments (number per year) 42 41 -1
Time (hours per year) 432 307.5 -125
Total tax rate (% profit) 49.8 38.1 -11.7
3
In 2007, informal firms in Kenya exhibited productivity profiles that are indistinguishable from their formal counterparts
In 2013, informal firms in Kenya exhibited productivity profiles that are quite different from their formal counterparts.
This differential effect has been associated with stronger business environments in other research.
18
Does the Business Environment Matter?
2007: Kernel Density Estimate of Value Added Per
Worker in Kenya
2013: Kernel Density Estimate of Value Added Per
Worker in Kenya Informal microenterprises
Formal microenterprises
Formal small enterprises
3
WHO IS GROWING AND WHO IS FORMALIZING?
Which sectors are growing and why?
What discourages firms from formalizing?
What are the perceived benefits from registration?
Business registration policies matter
19
1
2
3
4
Expansion defined as an increase in the number of employees, machines, or space used over the last 3 years
About 27% of the informal firms surveyed have “expanded” by this definition over the last 3 years
20
Which sectors are growing?
Differences in Firm Age (Median = 4 Yrs)
Differences in Manager Education
Differences in Type of Industry Regional Variation
Below Median Age Above Median Age
22%
32%
Services Other Manufacturing Furniture
26% 27%
43%
No / Primary Secondary or Higher
17%
31%
All Firms Central Nyanza Mombasa Nairobi Nakuru
27%
38%
18%15%
36%
26%
1
21
Factors Discouraging Willingness to Register Higher labor productivity is associated with a higher proportion of firms reporting each of the
above as reasons, with the exception of paying taxes, for not registering Considered individually, these reasons for not registering show significant variation across
regions and the education level of the manager, as seen below:
Central Nyanza Mombasa Nairobi Nakuru Full Sample
26
53
65
54
84
56
35 38
80
48
86
57
10
22
50
35
65
37
9 7
66
33
57
36
59
10
85
31
44 47
Time, fees and paperwork for registering Taxes paid by registered businessesInspections and public officials Bribes and corruptionNo benefit from registering
Rea
son
for n
it re
gist
erin
g (%
of f
irms)
2
22
Perceived Benefits from Registration Perceived benefits from registration vary by region and firm’s perceived severity of the
obstacles Controlling for region specific differences (region fixed effects), firms that are larger in terms of
monthly sales and have higher labor productivity are significantly more likely to report each of the below factors as a benefit from registering.
All firms Central Nyanza Mombasa Nairobi Nakuru
77
44
78 82 8390
61
30
7571 67
59
40
4
21
50 50 55
42
17
40
5547 46
Benefits from registering by region
Better access to finance Better access to raw materials, infrastructure and government services
Less bribes to pay Being able to issue receipts
Ben
efit
from
regi
ster
ing
(% o
f firm
s)
3
23
Business Registration Policies Matter The discussion above on whether or not firms would like to be registered as well as the obstacles to registering are based on firm’s perceptions.
However, perceptions may not always reflect the underlying objective reality of the costs and benefits of registering
Fortunately, for the case of Kenya, the World Bank’s Doing Business project provides information on select business environment measures for Mombasa, Nairobi and Nakuru regions.
We find some evidence that at least to some extent, firm’s perceptions reflect objective reality.
61%52%
40%54%
84%
65%
% of firms that would like to be registered% of firms that for whom high registration cost is a reason for not registering
Per
cent
age
of fi
rms
4
