The Indicator

Impact and Investment in the Informal Sector in East Africa

In this column called “The Indicator”, we will be taking an economic or financial statistic from East Africa and breaking it down into bite-sized nuggets of knowledge for investors.

This month’s indicator figure is 77.

77 of what?

Most of the financial community works in the formal sector.  This is incredibly uncommon in East Africa and in this month’s Indicator we uncover the percentage of people working in the informal economy, which comprises 77 percent of the workforce in East African Community (EAC) countries.

What do you mean by employment in the informal economy? 

According to the International Labor Organization’s definition, employment in the informal economy is work for oneself or another in an unincorporated business that is engaged in the production of goods and services. This includes anything from part-time work in trade or retail of a small shop to full time work in an off-the-books transportation firm. Typically agriculture, forestry, and fishing are excluded from the informal labor force. Inclusion of agricultural work would increase the informal economy size even further.

Determining the size of employment in the informal economy is by its nature incredibly difficult.  In the underlying sources we have used in this article, all sources used statistical analysis from samples taken in each of the countries. Therefore the numbers we present are estimates or extrapolations based upon available data and used to begin the conversation on the informal sector and market in the EAC.

Which EAC country has the largest and which has the smallest informal sector?

Due to its large population in their productive years of living, Tanzania has the largest informal sector with approximately 20.1 million people employed or 77% of its labor force.  On percentage terms Rwanda has the largest informal sector measured at just over 92% of total employment followed by Burundi with just under 92%.  Uganda has the lowest informal sector employment in percentage terms at 70%.

How does the EAC compare to other regions of the world in the size of the informal sector?

It should not be a surprise to most readers who interact with small providers of goods and services in the EAC that this part of the world has a very high informal sector, as do heavily populated areas with low GDP per capita figures.

For example, the informal sector of India is estimated to be 83% of total employment whereas developed nations in Western Europe and North America typically have less than 10% of the workforce in informal sector employment.

How much does the informal sector contribute to the economies of the EAC?

Our research suggests that the informal sector contributes 30-40% of the net GDP through provision of goods and services that are inputs to value chains such as agriculture, wholesale trade, and small retail services. This is lower than the Sub-Saharan African average of 42% of GDP from the informal sector.

Is the informal sector increasing or decreasing in the EAC?

The informal sector in the EAC is certainly growing. Along with the dramatic population growth in the EAC countries, some estimates suggest that up to 90% of new employment in East African countries is created in the informal sector.

Whereas growth in the formal sector jobs in banks, government, manufacturing, trade, or services is often planned and controlled, the pace of job growth in the informal sector is rampant with thousands of new young hustlers and hawkers starting fresh each month.

How does this affect the economies of East Africa?

Informal sector employers and employees run the constant risk of punishment, fines, as well as limited protection from policing or contract enforcement or cover from pension or other social support services.

Working in the informal sector is typically a combination of skills and choices.

A lack of skills in literacy, numeracy, and accounting are usually at the root of informal employment. As businesses mature, informality is a deliberate choice based upon challenges in administrative red tape, tax burdens, licensing requirements, corruption, safety requirements, and other challenges which add to end costs and make firms less competitive. Consumers of informal sector businesses support the continuation of the informal sector by virtue of their spending in the sector.

The government loses also, as it struggles to identify ways to collect tax on informal enterprises and employees. Estimates suggest that taxing informal sector sources can increase overall tax collections as much as 7% in Kenya, which, if allocated correctly, could fund a significant amount of infrastructure and social services to serve the needs of the workers in the informal sector.

What is being done to increase formal employment in EAC countries?

EAC countries have launched multiple initiatives to increase the formalization of their economies. As more informal businesses integrate into the formal sector we expect to see many changes to the tax, investment and labor dimensions of the newly formalized businesses and industries.

The transition will be difficult but many benefits will be gained. An increase in formal employment will increase job stability, training, and wages.  In addition, if more businesses and workers are able to be taxed, then tax revenue to governments will increase.

Rwanda, Tanzania, and Kenya have launched business formalization programs designed to bolster opportunities for workers, investment opportunities for enterprises and tax collections. These initiatives are off to a strong start but the informal sectors in these countries are quite large and pose their own challenges. The informal sector is not a new thing in the EAC. It is a longstanding part of the economy with its own norms, methods of operation, and business customs. It will take a significant amount of time to reach the goals of the formalization efforts.

It is certain that the informal sector is not going away anytime soon.

If the informal sector is here to stay, what are some potential investment themes to explore?

Where there are challenges or deficits business and investment opportunities often emerge.

The following is a brief summary of a few market opportunities and investment ideas that could play upon the large and growing informal sector in East Africa.

  • Mobile money – by now most everyone in finance in East Africa has heard of and used M-Pesa which provides transactional services via mobile phone without the need for a bank account and is heavily used by the informal sector to transfer money and pay bills.
  • Microfinance – an established means for informal sector business people to receive funding to grow their enterprises. In the past few years branchless microfinance has emerged as a reliable and rapid funding source for the informal sector under brand names such as M-Pawa in Tanzania run by a collaboration between Vodacom and CBA Bank and Jumo Finance providing back-end mobile savings and loans through Tigo and other mobile providers throughout Sub-Saharan Africa.
  • Informal sector distributors – getting goods and services to small duka shops in the urban informal sector has been a challenge for many large consumer goods manufacturers. This has been the focus of two companies in Kenya, Twiga Foods which has gotten a head start in distributing food and produce and Sokowatch which has developed an innovative means to get a diverse set of fast-moving consumer goods from global manufacturers to urban shops with aggressive expansion plans throughout the region.  SolarKiosk, a player in the rural markets throughout East Africa has taken the approach of running connected town centers surrounding a wholly owned electronics and consumer goods duka shop that would make the founders of Walmart salivate for the long-term growth prospects.

This is but a small list of several potential and emerging types of companies investing into and providing services to the informal sector in the EAC.

With the large but fragmented buying power of the informal sector, companies that can get services to these consumers are not only poised to prosper for themselves, but also play a large role in the overall growth and development of the economies of the EAC.

How can I learn more?

To learn more about the topics in this article you can visit:

International Labor Organization – http://laborsta.ilo.org/informal_economy_E.html

Websites for Ministries of Trade and Development in EAC countries

M-pesa – https://www.safaricom.co.ke/personal/m-pesa

M-Pawa  – https://vodacom.co.tz/mpesa/mpawa/welcome

Jumo finance – https://www.jumo.world/

Sokowatch – https://sokowatch.com/

Twiga Foods – http://twigafoods.com/

SolarKiosk  – http://solarkiosk.eu/

About the authors:

David L. Ross is Managing Director of Statera Capital and US Ambassador to the Open University of Tanzania active in growing companies in Eastern and Southern Africa through primary investment, investment advisory, strategic partnerships, and executive education. Connect on LinkedIn at http://tz.linkedin.com/in/davidlross1 or at david@stateracapital.com.

Catherine Mandler is a Senior Analyst at Statera Capital. Connect on LinkedIn at http://www.linkedin.com/in/CatherineMandler or at catherine@stateracapital.com.

 

 

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