Informal economies leave workers vulnerable: New markets help businesses make the leap
It can be valuable for a business to switch to the formal economy in the long run.
2020 has been a tough year for most people, but the world’s two billion informal workers and their families have been hardest hit.
Informal economies exist everywhere, but an estimated 93% of the world’s informal workers live in emerging economies. Almost nine in ten African workers are employed informally, along with more than two-thirds of workers in Asia and Latin America.
The International Labour Organization estimates that the pandemic has increased poverty among informal workers by more than 21% in upper-middle-income countries, and more than 50 percentage points in both high- and low-income countries. But even in “normal” times, life as an informal worker had many challenges. Workers in the informal economy tend to earn lower wages, are less likely to have savings, and can’t access unemployment benefits, government aid programmes, or other social safety nets. Furthermore, a lack of regulation means many people work in difficult or dangerous conditions.
Informal economies are problematic for other reasons, too. Cash-strapped governments can’t collect taxes from them, reducing their ability to provide services or enforce laws. It’s difficult for informal businesses to grow because they can’t access capital, and customers have difficulty knowing when someone they hire to do a job or make a product will follow through or produce quality work.
Given these challenges, what can be done to encourage businesses to transition into the formal economy?
Making transparency profitable
While it can be valuable for a business to switch to the formal economy in the long run – it allows them to access finance, grow, and exist with more stability – informal businesses have few incentives to make the switch in the short run, because taxes and regulations only add to the cost of doing business, making them less competitive.
In our research, we’ve discovered that business model innovation can play a key role in flipping the incentive structure.
Matias Recchia, co-founder of IguanaFix, found a way to incentivize the transition to the formal economy when he developed a new business model for home and office improvement in Argentina. Before he started IguanaFix, most plumbers, electricians, painters, movers, etc., worked informally in Argentina – barely getting by day-to-day – and constantly searching for work through word-of-mouth advertising. Because they weren’t part of the formal economy, they couldn’t access financing to grow their businesses; instead, they worked as much as they could and hoped for the best.
Recognizing their struggle, Recchia and his business partner, Andrés Bernasconi, devised a new business model where the benefits of working formally outweighed the disadvantages. Their company, IguanaFix, created a platform that enabled customers to hire contractors for home and office improvement jobs. Through their online service, contractors could tap into a significantly larger customer base, build their clientele, and gain more certainty of future work by booking projects in advance. Customers also benefited from the platform’s convenience as well as its policies and features, which helped guarantee reliability. Because IguanaFix required businesses to meet government regulations to ensure quality for customers, it provided a clear, immediate incentive for informal businesses to join the formal economy, even though they previously had little incentive to do so.
People are always eager to remove struggle from their lives, and IguanaFix generated $25 million in revenue during its first three years. More significantly for the South American countries where it operates, it has attracted tens of thousands of contractors to transition from the informal to the formal economy. This didn’t happen as a result of more laws or better enforcement, but because IguanaFix developed a business model where everyone involved was better off obeying the law and operating in the formal economy.
IguanaFix’s approach to solving problems associated with the informal economy is just one example – similar companies exist in Africa, Asia, and elsewhere. No single company or innovation will solve a country’s troubles overnight, but as more innovators build innovative business model solutions that incentivize participation in formal markets, economies will grow safer and more prosperous for workers and customers alike.
Lincoln Wilcox is a research associate at the Christensen Institute, where he researches ways in which individuals, businesses, governments, and nonprofits can leverage innovation to create prosperity in low-income countries and communities.
The article is published under the editorial partnership between Financial Nigeria and the Clayton Christensen Institute, to promote market innovation.
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