Enterprise Formalization: Fact or Fiction? – New ILO/GIZ Study on what works to formalize enterprises
Informality of enterprises seems to be a rational behaviour that can best be overcome by reducing the cost of formalization and by offering clear benefits like an extended coverage of social protection. This is one of the key findings of a new joint study of the International Labour Organization (ILO) and the German Agency for International Cooperation (GIZ) trying to summarize what works and what doesn’t work in formalizing the large informal enterprise sector in developing and emerging countries.
There is broad agreement that the high rates of enterprise informality prevailing in many developing countries should be reduced. Key arguments are to broaden the tax base, to improve the coverage of social protection, to reduce unfair competition, and to ultimately increase GDP levels.
Therefore, the International Labor Organization (ILO) and the German Agency for International Cooperation (GIZ) took stock of the existing empirical evidence concerning the impact of policies to stimulate informal enterprises to formalize. The new study basically shows that informality of enterprises seems to be a rational behaviour reflecting the high cost of becoming formal, the missing benefits of being formal, and the widely spread absence of law enforcement. Despite the general lack of solid empirical studies there are a couple of interesting findings on what works and what doesn’t.
Business entry reforms can increase firm registrations. Single reforms aiming to increase firm registration by reducing the cost of formalization need to offer a high reduction of registration payment (at least 50%) in order to have significant effects on the number of registered businesses. Single reforms aiming at reducing the length of registration procedures can have a significant effect starting from a 15 % reduction of the time needed for registration. Combining several reforms aiming at reducing the cost of formalization perform better and require less drastic reductions. Innovative approaches link the cost reduction of formalization to clear benefits such as easy access to social protection for entrepreneurs and workers of micro-enterprises.
The study presenting case studies from Argentina, Brazil, Colombia, and Sri Lanka is available on www.ilo.org/seed.
Therefore, the International Labor Organization (ILO) and the German Agency for International Cooperation (GIZ) took stock of the existing empirical evidence concerning the impact of policies to stimulate informal enterprises to formalize. The new study basically shows that informality of enterprises seems to be a rational behaviour reflecting the high cost of becoming formal, the missing benefits of being formal, and the widely spread absence of law enforcement. Despite the general lack of solid empirical studies there are a couple of interesting findings on what works and what doesn’t.
Business entry reforms can increase firm registrations. Single reforms aiming to increase firm registration by reducing the cost of formalization need to offer a high reduction of registration payment (at least 50%) in order to have significant effects on the number of registered businesses. Single reforms aiming at reducing the length of registration procedures can have a significant effect starting from a 15 % reduction of the time needed for registration. Combining several reforms aiming at reducing the cost of formalization perform better and require less drastic reductions. Innovative approaches link the cost reduction of formalization to clear benefits such as easy access to social protection for entrepreneurs and workers of micro-enterprises.
The study presenting case studies from Argentina, Brazil, Colombia, and Sri Lanka is available on www.ilo.org/seed.