Economic relations of production, distribution and employment tend to fall at some point on a continuum between formal sector at one pole and the informal sector at the other, with many categories in between. Depending on their circumstances, workers and units are known to move with varying ease and speed along the chain and/or to operate simultaneously at different points on the chain.
For example, the self-employed garment maker who supplements her earnings by stitching clothes under a sub-contract, or shifts to working on a sub-contract for a firm when her customers decide they prefer readymade garments rather than tailor-made ones.
The formal and the informal ends of the economic continuum are often dynamically linked. For instance, many informal enterprises have production or distribution relations with formal enterprises, supplying inputs, finished goods or services either through direct transactions or sub-contracting arrangements.
Also, many formal enterprises hire wage workers under informal employment relations. For example, many part-time workers, temporary workers and homeworkers work for formal enterprises through contracting or sub-contracting arrangements.
Few informal enterprises, except perhaps some survival activities, operate in total isolation from formal firms. Most source raw materials from and or supply finished goods to formal firms either directly or through intermediate (often informal) firms. Sourcing and supplying of goods or services can take place through individual transactions but are more likely to take place through a sub-sector network of commercial relationships or a value chain of sub-contracted relationships.
Without properly taking stock of these linkages, it is very difficult for those in the informal sector to reach their full potential because they continue to face the challenges inherent in their characteristics including poor bargaining power, lack of working capital, access to training and technology and lack of collateral to access financing.
Overall, strengthening the linkages between informal sector and the formal will result in tremendous improvement in operations of informal sector which can be observed in various areas such as;
i. Improved competitiveness of the informal sector through facilitating technological, knowledge and management skills transfer and capital injection.
ii. Behavioral transformation as entrepreneurs displays much higher commitment to the fulfillment of contracts.
iii. Improvement in revenue turnover and employment numbers.
iv. Increased domestic sourcing by transnational corporations and large local companies leading to import substitution.
v. The creation of higher quality jobs and or the preservation of these.
vi. The increased ability of commercial banks and other financial sector players to provide credit and other financial products to informal due to improved attractiveness.
vii. Strong deeply rooted local supply chains emanating from the informal sector to the formal corporates.
viii. A more dynamic private sector.
ix. An increased capacity to attract Foreign Direct Investment as the informal sector becomes more organized and accountable.
x. Increased contribution of the informal sector to direct and indirect taxes will enhance overall economic performance.
xi. The economy will become easier to measure and there will be better policy responses to policy as the size and extent of the informal sector players can be more easily ascertained or more accurately estimated.
For the economies to fully enjoy the benefits of the linkages created between the formal and the informal sector there is need for a more strategic approach to formal-informal linkages as instruments of institutional design that facilitate the exploitation of complementarities between formal and informal institutions. These would require first that the challenges of the informal sector be addressed among them those of inadequate policy framework; inadequate financial mechanisms and incentives; inadequate knowledge of markets, product quality, investments and technical knowledge; inadequate institutional support; and inadequate export infrastructure.
Regarding the inadequate financial mechanisms, the current trend that there is strong interest in credit by the informal sector, banks’ profit orientation deter them from supplying credit to them because of the high transaction costs and risks involved. First, these groups’ loan requirements are small, so the (more or less fixed) costs of processing the loans tend to be high relative to the loan amounts. Second, it is difficult for financial institutions to obtain the information necessary to assess the risks of new, unproven ventures, especially because the success of small firms often depends heavily on the abilities of the entrepreneur. Third, the probability of failure for new small ventures is considered to be high.
The above factors then discourage the financial institutions to avail resources to the informal sector. This can be easily be forgone if the informal sector in collaboration with the formal sector exploit the linkages that exist between them and approach banks for core financing. This would entail the larger formal sector players to act as the guarantee for the small informal sector player up to the time the later has adequate capacity and ability to seek funding from the financial institutions.
Informal sector players can also benefit from linkages with the formal sector through improving their competitiveness. With resources being availed through the linkage system the potential of the informal players can increased through improving on their competitiveness as they can be able to source new technology and improve the workers technology.
Sanderson Abel is an Economist. He writes in his capacity as Senior Economist for the Bankers Association of Zimbabwe. For your valuable feedback and comments related to this article, he can be contacted on email@example.com or on numbers 04-744686 and 0772463008