Tapping Hidden Fortunes

By Kuchta-Helbling, Catherine | Economic Review, January 2003 | Go to article overview

Tapping Hidden Fortunes


Kuchta-Helbling, Catherine, Economic Review


Informality and corruption waste vital resources and weaken political and economic institutions. Because informals are illegal, they don't benefit from law enforcement services such as the courts and the police that could offer them protection and reduced business risks. Some informals survive without these services by signing short-term small-scale agreements with known partners. Yet, this greatly lowers their productivity and flexibility. Other-in formals bribe government officials to obtain services or escape costly punishment for their illegality. Corruption pads the pockets of officials, robs the government of much needed revenue for essential services and raises the price of goods and services.

Centre for International Private Enterprise

Billions of dollars in potential profits are lost each year in emerging democracies and economies threatening to derail political and economic transitions worldwide. These losses result from ill-designed, complex laws and regulations that exclude millions of citizens from the political and economic system and unnecessarily raise the cost of doing business in the formal sector. High business costs force entrepreneurs of modest means to survive by operating low-income, low-growth activities in the informal sector, squandering their economic potential. Moreover, costly business regulations encourage investors to flock to more hospitable business climates causing other countries the loss of millions of dollars in badly needed investment. These factors greatly hinder competitiveness, profit-making and overall economic growth. They also impede a country's ability to benefit from globalisation. As a result, many citizens feel that they have not benefited enough from democratic and market-oriented reforms and oppose further reform initiatives. In some countries, widespread demands to reverse past reforms are mounting. Unless barriers to political and economic participation are removed in the near future, democratisation and market-reform could unravel across the globe.

A key barrier is the cost of doing business in the formal economy. Entrepreneurs who want to become and remain formal must spend time and money to obtain a business license, acquire land titles or leases, hire employees, comply with government laws 'and regulations--pay taxes, for example, obtain credit, hook up and maintain electricity and telephone services, enforce contracts, and so forth.

How expensive these procedures are, fluctuates widely from country to country. Exorbitant business costs are found in nations where business people must follow burdensome laws and regulations and deal with inefficient, corrupt government agencies which offer few benefits. High costs force entrepreneurs to make calculated. decisions as to which rules they will respect or violate based on what they can afford without having to go out of business, what they expect to receive in return, and the cost of noncompliance. Many entrepreneurs producing legitimate products lower their business costs by operating informally without proper permits and legal status. Hence, they are called the informal sector or "informals."

Every economy--developed or emerging--has an informal sector. New York City sweatshops are notorious examples of informality in the US. What is alarming is that the already large informal sectors in many emerging democracies and economies continue to grow. A recent IMF study reveals that about nine trillion dollars -- roughly a third of the GOP of emerging markets -- was produced informally. Similarly, 1999 International Labour Organization figures indicate that 17% to 84% of the urban labour force in developing countries work informally.

What's wrong with high business costs and large informal sectors?

To begin with, a large informal sector weakens democracy, hinders necessary reforms and contributes to misguided policies. Informals, if given the opportunity, are likely to suggest useful policy changes that would reduce the cost of doing business and level the playing field. …

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