The Perils of Including Informal Economies

In many countries dual “economies” or markets are prevalent. Alongside a mainstream economy, unregistered businesses operate in a vast informal sector. Typically, lack of capital, skills and knowledge detrimentally impact work conditions and environment. Such businesses primarily cater to the needs of low-income households and often have their prime place of operation in densely populated areas with over-stretched infrastructure and services. Business income is volatile since poorer households tend to feel the impact of economic swings more quickly and severely. Lack of employment opportunities and low entry barriers facilitate business start-ups to provide subsistence income, sizeable indirect contributions to GDPs. Although the majority of businesses tend to be small family businesses, partnerships or cooperatives there are also larger businesses. Their growth is confined by numerous obstacles. Invariably, informal businesses hit a growth ceiling. Businesses are informally organised in many different ways, such as tribal, cultural, religious backgrounds, cooperatives, group-loan groups, trade associations, etc. Informal “taxes” such as fees for protection and stand rentals are customary. Immigration and migrations within countries from rural to urban areas have transformed (regional) informal economies. The obfuscated nature of informal economies hinders the efforts of development practitioners, governments and academics to progress their integration into formal economies.

Frugal Innovation

Formal businesses have discovered the potential of BoP markets, obviously not entirely selflessly and often driven by declining formal markets or demand from existing customers. In her study, Kate Meagher looks at the relationship of big businesses and informal economies through the lens of “frugal innovation” which “seeks to improve welfare and promote agency among lower-income groups through the collaborative development of high-quality, low-cost goods and services.” Being sensitive to existing values, informal and big businesses, collaboratively redevelop products and services to better fulfil the social and aspirational needs of low-income households. This approach has the potential to transfer skills and resources to informal businesses. In return, they share their market knowledge and networks with formal businesses while also improving access to higher quality products and services. While there may have been some positive outcomes, Kate Meagher's study critiques its methods. In the final part, she briefly draws on two case studies to prove her points.

Fraught Implementation

The author suggests that formal businesses presume that the two sectors are complementary in terms of systems and structures. Any differences are, therefore, surmountable by making resources available. Meagher argues that such thinking ignores that not all informal businesses are small and poor, and informal sectors are not merely ”local markets”. As an example of this, she refers to the international transactions of money and goods taking place between and to informal economies. She is concerned “how frugal innovation reshapes institutional arrangements in the informal economy” and concludes “that frugal innovation is as much about power as about inclusion, and raises new questions about the motives and terms of inclusion.” (p.3) As a result, existing structures supporting a functioning informal economy could be weakened, “suppressing and cannibalizing rather than strengthening informal economic systems.” She also ascertains that this process is selective and compares it with colonial systems that distinguished between usable and unusable parts of Africa. She questions the ulterior motives of targeting youth, women and migrants as they also tend to be cheaper labour. In her review of somewhat dated literature, a prevalent view emerges that structures in informal economies are “incapable of efficient or large-scale self-organization.”
 

Implementation Strategies

Meagher aims to expose strategies used by formal businesses to restructure informal economies so that they can better serve their interests to reduce transaction costs and maximise profits through harmonizing differences. She names the following four:

1. Copying: this describes the process of copying an existing business practice to use in other areas or at a larger scale. She gives “micro-packaging” as an example which micro-businesses use to break up bulk purchases to make produce more affordable. She argues that the copying of this practice by the big businesses may crowd out informal traders.

2. Free-riding is also called “leveraging soft networks” thereby using informal networks as a marketing strategy to reduce the cost of market entry. This would also reduce the competitive advantage that communities have. “In contrast to claims of complementarity, recent ethnographic studies of micro-insurance, micro-credit, and other branded products and services have highlighted the aggressive appropriation of social networks and informal institutions to access informal labour and consumer markets on the cheap, at little benefit to informal actors.”

3. Short-circuiting refers to the business practice to cut-out informal agents, distributors, intermediaries etc. and to directly source from informal manufacturers and/or relying on them for distribution. Meagher mentions that non-profit making NGOs are used as business brokers.

4. Shifting risks to informal households and actors “through microcredit-based payment solutions and micro-franchising arrangements”. For example, the requirement to bulk-buy products for resale transfers the risk of lack of demand to micro-traders or agents. Meaghre claims: “While relieving large corporations of the costs and risks of formal employment in unstable low-income markets, engagement with informal distribution systems simply transfers these costs and risk onto the shoulders of poor informal actors, often women and youth.”  

The author concludes her criticism of big business under the banner for frugal innovation with a harsh judgement: “Clearly, one person’s inclusion is another person’s exploitation” that should give rise to concerns about the academic value of her study.

Brief Case Studies

In the last part, she focuses on mobile money provider Safaricom (M-Pesa) and South Africa's micro-insurance operator Hollard to “illustrate the adverse and disempowering effects of frugal innovation strategies from an informal economy perspective”.

She accuses Safaricom of centralising management control, shifting costs and keeping the profits following its successful service roll-out on the back of existing informal infrastructure. Likewise, South Africa's Hollard fares no better. She describes how big insurance businesses copied products successfully sold by informal funeral societies. “Free-riding” on the familiarity with this product already built by them, Meagher claims that they ended up being cut out by the introduction through new sales channels such as formal sector payment points and mobile payment.

Concluding remarks

Our vision is to promote the integration of informal businesses into the mainstream economy. Therefore studies such as this attract our attention. It is interesting to read about the purported perils of the collaboration between formal and informal businesses, mainly portrayed as the interests pursued by big corporations at the expense of informal economies.

However, in my opinion, the study misses addressing the concern raised: the weakening of informal structures. It references mostly older literature, is contradicting in some points, generalising and superficial. It presumes that most informal economies are functioning. To the contrary, most experience high unemployment, low business start-up survival rates, meagre investments, high crime rates, few low-skilled apprenticeship opportunities, little innovation capabilities and informal law enforcement by domineering clans or tribes. The “informal structures” referred to in this study appear to be distribution channels, products and services.

Development of economies necessitates changes, and consequential, industries have disappeared either due to competition or innovation. Not long ago, the small family-run corner shops fell victim to supermarket chains. Nowadays, big is not necessarily beautiful. Some major high-street based store chains succumbed to the competition from smaller incoming discounters and online shops. Robots and AI are replacing jobs for the low-skilled, etc. We are seeing the traditional car-industry being put under pressure by competition from electric-car manufacturers and lawmakers. Unquestionably, the consequences of change are not always positive. However, many have resulted in greater prosperity for a broader part of the population. Surely, basic economic principles operate in informal economies, and change is, therefore, inevitable. In our experience, informal market participants have reshaped the ownership structures of small grocery stores. African immigrants arriving in South African townships are organised in buyer-coops to take advantage of lower bulk-buying prices. It resulted in lower prices for the locals, and soon domination of “foreign” owned grocery stores.

Further, it is contradictory to suggest frugal innovation to contribute to better working conditions in informal economies. It would both require and cause changes in “informal structures” deplored by the author.

The case studies fail to explain how the corporates weakened informal structures. Where two parties in a relationship such as the collaboration partners in frugal innovation, differ vastly in size, it does not take much for the domineering partner to come across as exploitative and ignorant. A business needs to make a profit, albeit sustainably treating customers, staff and suppliers fairly. The study does not give Safaricom a chance to explain why it changed management and sales structures. It remains debatable whether Safaricom would have reached a growth ceiling had it continued the business model through which it successfully established itself in the market. Have the copying and free-riding only had disadvantages or perhaps benefits such as broader, cheaper and easier access to products and services? Have more employment opportunities been created in the formal sector for those who would give up their informal subsistence any time for employment? The case studies and the study itself leave more questions than answers.

Source:

Meagher, Kate (2017). Cannibalizing the informal economy: Frugal innovation and economic inclusion in Africa. European Journal of Development Research ISSN 0957-8811.