Informal sector: the untapped goldmine

LAHORE: Informal economy that is neither taxed nor monitored by any form of government unlike the formal economy, breeds on corruption taxes productivity and competitiveness.

Slow improvement in quality of regulation in Pakistan is due to many antiquated laws enforced by autonomous and government institutions at federal, provincial, and local levels.

The government will have to improve governance, eliminate corruption and upgrade laws to discourage informality. In the current scenario even the firms in formal sector are forced to carry out informal activities.

In Pakistan, there are three types of private firms. In one of the categories firms are too small to be regulated either by choice or not. The regulators in fact lack the capacity to govern most of the 3.2 million small and medium enterprises operating in the country. Most of them are so small that they do not earn enough to be taxed. The second type of enterprises earns enough to fall into the tax net.

However they do not want to be formalised and thus operate informally.

The third category belongs to firms that a formal but also carry out informal activities.

This does indicate that opportunity cost of informality is there. Informality may not save money for the enterprises as they end up parting with substantial amount by bribing the regulators to remain outside the tax net.

Informality saves them from many hassles that their colleagues in formal sector face. In fact the informal operators are surprised to note that those operating formally are also forced to grease the palms to avoid audit, scrutiny, and get their tax returns accepted. So they get away by paying the ‘bureaucratic tax’ instead of paying government taxes.

The local firms are unable to cope with the demands of globalisation.

Their markets are being poached by global companies while they lack the quality and competitiveness to penetrate in foreign markets.

As a result, enforcement brings arbitrary discretion on the part of government officials, causes high official and unofficial compliance costs on formal firms, and forces others to operate informally. Small firms the world over increase in size as they grow by acquiring new technologies.

This is not so in our country where the growth of most small enterprises remains stunted. This is mostly because of informality. The firms that started small and informal would have to acquire new technology to increase productivity and market reach.

This needs a lot of documentation which leads to formalisation of their business. This they do not want. As small and informal firms they do not need skills and in firms where skills are needed the skilled labor force does not want to join them as they do not see career in small enterprises.

When the investment climate improves in the country it is the larger formal firms that benefit from it. The more formal and larger enterprises are better able to cope and mitigate adverse forces in the investment climate and are also ready to take advantage of upturns and improvements. The financial sector still needs reforms to cope with the huge financial needs of smaller firms. The sector needs to develop products that could provide small enterprises access to finances without collateral.

The role of the government as the regulator of interest rates of National Saving Schemes (NSS) has to be restricted. We cannot have dual system under which the mark-ups under the NSS are much higher than that offered by the commercial banks.

Development of secondary market for raising capital is badly needed in the country. The larger corporate sector should fulfill most of its financial needs through term finance certificate and sukuk bonds.

This will leave banks with surplus cash and they would be forced to introduce new financial products for smaller firms.

Most small enterprises that own land are deprived of loans because the property rights are not clear.

Without clear property rights, lenders will not consider land as loan collateral without an original sale deed in the bank’s possession. We have to breathe new life this dead capital.