Archives for category: Informal economy

I was slightly depressed after reading the highlights of the 2013 Kenya Economic Survey (pdf). Almost all topics we discuss in this blog, like employment, wages, industrial development and balance of trade, do not look good. Here are some highlights of the highlights:

Industrial development: not really happening

The manufacturing Sector decelerated from an  expansion 3.4 per cent in 2011 to a growth rate of  3.1 per cent in 2012. The slower growth was due to high cost of production, stiff competition from imported goods, high cost of credit and political uncertainty due to the 2013 General  Elections

Employment: 90 percent of new jobs are informal. Wages are falling

  • The labour market recorded 659.4 thousand new jobs in 2012, 89.7 percent of them were in the informal sector representing an increase of 5.5 per cent.
  • Real average wages declined by 4.8 per cent due to inflation.
  • The creation of new jobs in the “modern sector” declined from 74.2 thousands in 2011 to 68.0 thousand in 2012.

 International trade: a growing deficit

  • Kenya’s trade balance worsened further by 8.7 per cent in 2012 compared to 46.7 per cent in 2011
  • The current account deteriorated to a deficit of KSh359.5 billion in 2012 from a deficit of 340.2 billion in 2011.

There are not only bad news in the report, for example there has been increased job creation in the construction sector, ICT industries as well as the education and health activities. And inflation has gone down, which is very good news for the lower income population. But that’s not enough for sustained economic growth over the long term.

Tourism has gone down too by the way. More here

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Paul Kinuthia (on the right) – Photo Credit: Business Daily

Paul Kinuthia started a small cosmetics business in the Kariobangi Light Industries (in Nairobi) 20 years ago with a start-up capital of 3000 KSh (less than 40 USD). He sold it to L’Oreal last week for over KSh 3 billion (about USD 35 million). Here’s the story on Forbes and on Business Daily.

Of course extreme success stories like Paul Kinuthia’s do not happen on a daily basis in Kariobangi. But, as I’ve said before, there is large diversity and growth potential in places like Kariobangi, although we like to call them “informal economy” or “survival clusters”. An excerpt from the Forbes article:

Kinuthia has a remarkable story. In 1995, he started off manufacturing shampoos and conditioners from a makeshift apartment in Nairobi with start-up capital of Ksh 3,000 ($40). He made these products manually using plastic drums and a huge mixing stick and heating oils, delivering his products by handcart to local salons and hairdressers. In the beginning, commercial banks refused to fund his venture while mainstream salons, beauty parlours and large retail outlets refused to stock his product because it was too native.

As the demand for his products grew, Kinuthia moved the business into bigger premises in downtown Nairobi and expanded his product range to include hair gels and pomades. While the bigger, sophisticated salons and supermarkets snubbed his products, they were very popular with street side local hairdressers because of their availability and significantly lower prices in comparison to the products on the shelves of the big retail outlets. As the products became more popular with local hairdressers, Kinuthia ploughed back his profits into moving into an even bigger place, financing growth, increasing his production capacity and extending his product range. In 1996, he incorporated a limited liability company and went on to produce body lotions and hair treatments. The new company set up better operational strategies, laying emphasis on quality and improving its packaging. By the late 90s, the company’s products were commercially available across Kenya’s mainstream retail and wholesale chains and were already commanding a sizable market share. By 2001, the company was already exporting its products to neighbouring TanzaniaUganda and Rwanda.

But despite the huge success of his business, Paul Kinuthia maintained one common characteristic of Kariobangi entrepreneurs – he doesn’t like questions from strangers. When Forbes called him for an interview, his secretary kindly relplied “Mr Kinuthia is not available”. I know the feeling very well.

More here

Uhuru and Ruto wrote in the Jubilee Manifesto that they plan to establish a development Bank to “prop up the private players”. Although nobody is talking about it, and although we have no idea if that will happen anytime soon, this could be a huge deal for the future of Kenya. What is a development bank? And is it a good or a bad idea for Kenya?

A traditional definition of a development bank is one which is a national or regional financial institution designed to provide medium-and long-term capital for productive investment, often accompanied by technical assistance, in less-developed areas. Development banks fill a gap left by undeveloped capital markets and the reluctance of commercial banks to offer long-term financing. [full “primer on development banking” here]

We have to keep in mind is that UhuRuto provided no details about how a development bank fits into their grand scheme for economic development in Kenya. For example, we don’t know if the objective is to promote small businesses (like the informal sector or SMEs), whether they want to finance large infrastructural projects, agriculture or large manufacturing industries.  However, the sure thing is that whenever the plan is to increase the government role in the economy, you attract both huge praise and criticism:  that’s the difference between the “industrial policy view” and the “political view”

According to the industrial policy view, development banks do more than just lending to build large infrastructure projects. They also lend to companies that would not undertake projects if it was not for the availability of long-term, subsidized funding of a development bank. Furthermore, development banks may provide firms with capital conditional on operational improvements and performance targets. In such circumstances, we would expect to see the firms who borrow from development banks increasing capital investments and overall profitability after they get a loan.

According to the political view, on the other hand, lending by development banks leads to misallocation of credit for two reasons. First, development banks tend to bailout companies that would otherwise fail (this is the soft-budget constraint hypothesis, e.g. Kornai, 1979). Second, the rent-seeking hypothesis argues that politicians create and maintain state-owned banks not to channel funds to socially efficient uses, but rather to maximize their personal objectives or engage in patronage deals with politically-connected industrialists.

So, whether a development bank is a good idea or not for Kenya entirely depends on your opinion on the current political class: will they be committed-to-development or good-old rent-seekers? For now I want to keep on the optimist side.

The state of Lagos in Nigeria decided to embrace de Soto’s “Legalist” idea of development and to start a process of mass formalization of the informal sector. I don’t know if Hernando de Soto will go there in person, but his Peru-based think tank – the Institute of Liberty and Democracy- is involved in the project. From an article in This Day Live:

The Lagos State Government has begun a comprehensive reform process, which it designed to formalise about 90 per cent assets currently locked in the state’s informal sector.

the state government had trained more than 100 enumerators in collaboration with the Institute for Liberty and Democracy (ILD), Peru to assist in data collation and information gathering under the state’s informal sector reform initiative.

.. Raji [Ministry of Commerce and Industry] said the state government was interested in having comprehensive information about the sector, and know why most people choose to operate informally, and, then work out modalities that will help in formulation policies that will encourage their migration to the formal sector.

Giving more recognition to informal operators is undoubtedly a good thing, but I wonder how far this can go. The Legalist school argues that formalizing property rights in the informal sector would trigger a virtuous cycle: business formalization turns “dead capital” (i.e. capital without property rights) into real collateral. Real collateral allows access to formal finance and new markets. Increased access to formal finance encourages business investments. Increased investments … I bet you can guess the rest of the story.

I used to like de Soto’s ideas, and to some extent I still do: as simple as they are, they point to the right direction – informal economies have a large development potential. But I turned more critical when I realized that his simple arguments have transformed into an over-simplification of reality. The equation “business registration=formalization” neglects that most activities in the informal economy are sustained by an infrastructure of (non-formal) regulatory, financial and welfare institutions beyond the reach of official governance. The central question raised in Lagos, “to know why most people choose to operate informally, and, then … encourage their migration to the formal sector” misses the point. The question should be reversed: we should try to understand how informal firms and their institutions work in practice, and to determine how formal institutions can “scale-down” and become appropriate for their needs – definitely not the other way around.

The “Africa rising” narrative in Kenya is always linked to the ICT sector, in particular mobile technologies, mobile apps, and internet-based applications. I wonder what will happen to this optimism after learning that Mocality, one of the big investors in this field, decided to shut down:

“Mocality has achieved some incredible things over the last four years, and has touched the lives of many people in Africa, but alas, all good things must come to an end.”

Few ICT enthusiasts in Kenya saw this announcement coming. Mocality, the online business directory owned by Naspers, a South Africa-based media company, will close down operations in Kenya and Nigeria on February 28th. In 4 years Mocality managed to register over 100.000 businesses in Kenya. The plan was to expand throughout Africa and create the largest business directory in the continent –none of this will happen.

Is this a hit to ICT-led afro-optimism?

To some extent, I believe it is. Or at least, it has brought some realism back to the discussion on ICT in Africa. In this blog I always argued that the expansion of the ICT sector is a great opportunity, but it has to go hand by hand with expansion in the industrial sector, manufacturing in particular, or it’ll be a hype, or even a bubble, with little effects on job creation and sustained economic growth. But if you look at the media coverage on the topic, hype has been all over the place. Look at Wired UK a year ago:

Want to become an internet billionaire? Move to Africa”:

If you want to become extremely wealthy over the next five years, and you have a basic grasp of technology, here’s a no-brainer: move to Africa.

Wired is not the Journal of Development Economics, and the exaggeration is probably intentional (I hope so anyway), but it signals the hype surrounding the ICT sector in the continent.

Perhaps Mocality made its move in the Kenyan market a little too early. Perhaps the problem is much deeper and the Kenyan market is simply not ripe for this kind of business. Mocality did not explain the reasons behind their decisions to close down, but rumors are that  the operating costs were too high and the returns on the investment were not satisfactory. We can’t forget that the Kenyan economy is still largely informal and being online or not doesn’t make much of a difference for most enterprises.

But Kenya is also a fast-growing and fast-evolving economy, and the optimists among us might argue that Mocality is leaving the market just a little too early. Mocality CEO Neil Schwartzman had a very different opinion, however, stating that:

“reaching profitability was not a reasonable near-term prospect.”

Ouch

Thorsten Beck, one of the world’s major experts in SME finance, argues that the “size” of the SME sector in an economy does not really matter for economic development. What counts is its dynamism:

Policy efforts targeted at SMEs have often been justified with arguments that (1) SMEs are an engine of innovation and growth and (2) they help reduce poverty because they are labor-intensive and thus stimulate job growth, but (3) they are constrained by institutional and market failures. Cross-country, country-level, and microeconomic studies, however, do not support these claims. One study shows that, although faster-growing economies have a higher share of SME employment in their manufacturing sectors, it is not the size of this segment that drives growth.

… The empirical evidence thus points to the entry of new firms—which are mostly small at entry—and the possibilities for successful SMEs to grow as decisive. It is not the size of the SME segment but their dynamism that helps economic development. Recognizing dynamism rather than size of the SME sector as the source of economic development identifies another important distinction that analysts should make among the firm population: informal microenterprises, the establishment of which is often the result of a lack of alternative economic opportunities, and small formal enterprises, some of which might have high growth potential.

I do not entirely agree on the last point. Although it is true that many businesses operate for survival, my experience in Kenya is that the distinction between “informal microenterprise” and “small formal enterprise” is just not clear in the real economy.

I see this blurry boundary as a sign that dynamism can occur at an extremely small scale, namely the “micro-to-small” (MSE) segment. If we go to an even smaller scale, the “graduation” of some businesses from “self-employment” to “micro-enterprise” is also very interesting. In other words, whenever a business is growth-oriented, no matter how “micro” it is, should get more attention

More (from Thorsten Beck’s paper) here

Looking at some facts, I am inclined to say no:

There are currently an estimated 300,000 groups, which collectively hold a combined asset base of at least Ksh300-billion.

Popularly known as chamas by Kenyans (loosely translated as “committees”), investment groups became visible during the 1980s and 1990s when the country’s economy was struggling, and were formed for social welfare purposes. Chamas have matured over the years, with some registering as companies and other investment vehicles. Most of the groups initially invested at the Nairobi Securities Exchange and the real estate sector.

You might remember an interesting post on the Open Book Blog where David Roodman asks whether microfinance is a Schumpeterian dead end.  In that post, Lant Pritchett talks about a trip to India when he was asked how self-help groups work in his own country. The answer: they do not exist, therefore they can be considered a Schumpeterian dead end.

I was asked the exact same question a couple of months ago during a meeting with a group in Nairobi. I  had never thought about it before, so I was caught unprepared, but my instinctive answer was that self-help groups have not disappeared in my country; rather, at some point they evolved into other types of organization like credit unions, social enterprises or formal investment groups.

I need to read lots more on this topic. But my impression so far is that instead of being a sign of backwardness or a dead end, chamas in Kenya tend to evolve over time and to combine elements of “welfare” and “investment” as different opportunities arise -depending on the needs (and salaries) of group members. For the poor, chamas help tackling the huge problem of income volatility; for richer people, they are a vehicle for investments and business growth.

The past month has probably been the most exciting (and busy!) of the entire fieldwork. After spending a lot of time meeting entrepreneurs and introducing ourselves in Kariobangi, we realized that we achieved the greatest of our goals: entrepreneurs started to trust us and our project – doors started to gradually open up for the collection of (what looks like) really good data.  Ah, the greatest joy for a researcher!

We were not that confident a few months back; we realized that in a context of informality and semi-formality like Kariobangi, entrepreneurs aren’t always willing to share private info with us. Sloppy data collection will easily get us trapped in the infamous GIGO rule  “garbage in, garbage out”: no matter what fancy econometric techniques we use, if the data is inaccurate, our work has no chance but being garbage. That’s when we decided not to rush in filling up questionnaires and to make several pre-visits to get to know the entrepreneurs and their business. It was worth investing the time.

We also realized that within our sample, semi-formal businesses complying with some (but not all) government regulations are more afraid to share information than the very informal businesses, which comply with no legal requirements. Last week, an entrepreneur of a semi-formal business made this point quite clearly:

 It can be riskier to comply with some regulations than not  complying at all. Informal self-employment is generally tolerated by the authorities. They say it alleviates poverty and it helps people to make an income. But as soon as you try to expand your business and to become a little more ‘formal’, problems start coming. Having a ‘Semi-formal’ business – as you call it – can be risky. The moment you try to expand is the moment you start being worried about people asking questions

I just noticed that my documents folder called “African development literature” is starting to look like a wildlife safari brochure: I have “Lions on the Move“, “Cheetahs VS Hippos“,”Are the Cheetahs Tracking the Tigers?“, “The Informal sector Elephant“, “Milking the Elephant“, “Stock markets in Africa: Emerging lions or white elephants?“. I haven’t seen any rhinos or giraffes, so maybe I will keep them for my dissertation title.

This morning’s addition was “Constrained Gazelles: High Potentials in West Africa’s Informal Economy” (link fixed) by Michael Grimm, Peter Knorringa and Jann Lay. Although I am not a big fan of the title, the paper does a great job in identifying a third type of entrepreneur in informal markets in addition to the well-known “survival” and “growth-oriented” businesses. The abstract:

The informal sector is typically characterised as being very heterogeneous and possibly composed by two clearly distinct segments, sometimes called the lower and upper tier. However, empirical evidence shows that even among lower tier entrepreneurs profitability can be quite high. We combine these findings and develop an innovative empirical approach to identify what we call ‘constrained gazelles’, next to the survivalists in the lower tier and growth-oriented top-performers in the upper tier. Our representative sample of informal entrepreneurs in seven West-African countries allows us to link the relative size of these three groups of entrepreneurs to the structural and macroeconomic environment in these countries.

As I mentioned in a recent post, growth-oriented enterprises emerge also in very difficult environments. The problem for academics, and even more for MFIs and banks, is to identify those who are more likely to innovate, create employment and be successful in the market, and to design specific financial products for them. Though, as the Roving Bandit reported recently, this is everything but an easy task.

Here’s an excerpt of Grimm et al ‘s  conclusions:

We empirically identify a third segment of entrepreneurs that are neither top performers nor survivalists. This group – which we label ‘constrained gazelles’ – shares many characteristics with top-performers, they even show similar managerial abilities in running their firm, but they operate with substantially lower stocks of capital. Their stock of capital is almost as low as that of most survivalists. However, they are much more productive and can thus earn much higher returns to capital than survivalists. If we take the mean value added-capital among constrained gazelles as reference, we find that an investment of Intl. $ 10 leads to a monthly increase in value added of almost Intl. $ 4.5. Amongst survivalists, in contrast, we estimate the marginal return to capital to be around Intl. $ 0.4 only, i.e. less than a tenth of it.

One of the biggest obstacles to industrialization in Africa is that African countries trade very little between themselves, only 10-12 percent of total trade, whereas regional trade accounts for 63% in EU, 40% in the US and 30% in Asean countries. Why do we have such daunting figures?

In addition to the well-known problem of tariff and non-tariff barriers, economists often argue that the root-cause is much more structural: African economies are excessively small and similar to trade among each other, so they must rely on international markets. From this view, intra-African trade is unlikely to promote growth in the short term.

However, the World Bank just-released report “De-fragmenting Africa” (highly recommended), tells a different story:

It has been commonly argued that regional integration can only play a limited role in Africa because of the similarity of endowments between countries. However, this does not reflect  the enormous opportunities for cross-border trade in agricultural products from areas with a food surplus to food deficit areas that result from differing seasons and production patterns. For example, Southern Malawi is not well endowed with agricultural potential and is a persistent food deficit area. Nearby Northern Mozambique is a productive area for growing maize, the main staple of the region, but it is distant from the main area of national consumption in the south of the country. Differences in weather patterns entail low correlations in production between countries and that regional production is less variable than production at the country level.

There is also another point: intra-African trade is already much bigger than statistics reveal, but most of it is informal:

There is a significant amount of cross-border trade that takes place between African countries that is not measured and therefore official statistics considerably understate the amount of intra-regional trade. (…) Surveys indicate that in some African countries, informal regional trade flows represent up to 90 per cent of official flows. In Uganda, for instance, informal trade grew by 300 percent from 2007 to 2009, where informal exports to neighbors is estimated to account for around 86 percent of official export flows to these countries

It would be interesting to have comparable data on informal cross-border trade, in particular on manufacturing goods, but I didn’t see any in the report. The graph below shows interesting patterns of (formal and informal) trade of food commodities in East Africa.

Read the full report here (PDF)