Long viewed as a barrier to market development and fiscal sustainability, a dynamic informal economy is increasingly being recognised as an important source of resilience and a target for financial technology (fintech) services. The informal economy accounts for approximately one-third of economic activity in emerging markets, compared to 15% in more mature markets, underscoring its outsized impact. Also known as the “shadow” or “grey” economy, the informal sector comprises legal activities that contribute to the economy but are not taxed or regulated by the government or covered by formal agreements. According to the International Labour Organisation, at least 2bn workers over the age of 15 – or some 60% of the global workforce – spend at least some time in the informal sector.
Economic Resilience
Although a large informal sector can constrain growth, limit government tax revenue and weaken the financial sector, informal micro-, small and medium-sized enterprises (MSMEs) contribute to the formal economy in a variety of ways, such as through value-added tax on purchases, or the incidental costs of operating a business. The widespread transfer of funds from the informal sector to the formal sector suggests that emerging markets may be more resilient to shocks than official metrics suggest. Nonetheless, access to credit remains an obstacle to growth and formalisation for many small firms.
Approximately 40% of MSMEs around the world – or some 65m firms – face a cumulative annual credit gap of $5.2trn, according to the International Finance Corporation, underscoring a sizeable opportunity for microlending in emerging markets. While informal workers are typically paid less than their formally employed peers, the informal sector in emerging markets tends to be more dynamic and competitive, nurturing the development of human resources when more traditional opportunities are absent or inaccessible.
Similarly, the MSMEs that make up the bulk of the informal economy represent a highly flexible form of employment capable of providing jobs to large portions of a given country’s population, even when official unemployment figures remain high.
New Tech
The uptake of new technologies can encourage formalisation through increased financial inclusion. Fintech, including tools based on blockchain, has helped improve access to finance in emerging markets. The sharp rise in remittances witnessed during the Covid-19 pandemic attests to the wide scale of informal remittances globally, often in cash and outside of traditional or digital banking channels Remittances to Africa grew by $80bn in 2020, with intermediary platforms such as East Africa’s Pangea supporting the flow of funds into local entrepreneurial activity.
Mobile money has seen especially robust adoption in many emerging markets. M-Pesa, an African money-transfer service that allows users to make payments and store and receive funds via their mobile phones, is a notable example of this trend. Launched in 2007 by Vodafone and Safaricon, Kenya’s largest mobile operator, the service is used by 51m people across seven African countries and is set to expand to Ethiopia following an October 2022 licence approval.
Digital currencies are another route that governments are using to increase financial inclusion. Around 90% of the world’s central banks are set to deploy digital currencies, as many consumers in emerging markets shift to virtual currencies to protect against inflation. In 2021 Nigeria rolled out the eNaira, Africa’s first digital currency. Uptake remains low, however: roughly one in 200 people used the currency as of October of 2022, a performance attributed to hesitancy related to the depreciation of the naira and confusion after a government crackdown on cryptocurrencies. Emerging market consumers generally exhibit more support for digital currencies than those in mature ones, with a Morning Consult report noting that 36% or respondents in India strongly supported the adoption of a central bank digital currency, compared to roughly 3% in Japan.
Read More from OBG
