Some people prefer working in the shadows

Originally Published: https://madamasr.com/en/2019/07/12/feature/economy/some-people-prefer-working-in-the-shadows/

Egypt’s vast informal economy has drawn the focus of government officials in recent years. Authorities have been looking to merge the informal economy with the formal economy as quickly as possible in order to boost official economic figures, which have been marked by low rates of growth and which officials say do not reflect the true size of the economy.

The government’s incentive to integrate the informal economy is clear. With an estimated value of LE 2 trillion, unregistered businesses are a potential source of substantial tax revenues for the state. The government is also eyeing the money collected by state bureaucrats through the extortion of unregistered businesses, a widespread practice in the informal economy that operates through kickbacks.

Proponents also argue that registering businesses in the formal system allows for a more competitive marketplace, as informal businesses are able to undercut their registered competitors by foregoing taxes and pensions. The disparity can be a serious source of consternation, exemplified in the comment of Mohamed al-Sewedy — a businessman, member of parliament and head of the Federation of Industries — who proclaimed during a parliamentary session that “the real terrorism in the country is the informal sector.”

According to the Minister of Planning, Hala el-Saeed, the solution is simple: provide incentives to micro enterprises and small enterprises — which traditionally represent the majority of the informal sector — by streamlining bureaucratic procedures and issuing tax incentives.

Yet this strategy to incentivize informal businesses to officially register has already been on the books for the last 20 years, when Egypt first began attempting to implement a system to fast track the registration process, and the informal economy has nevertheless continued to grow.

The state approaches the issue as a strictly binary one — a formal versus an informal economy — leading to an overly simplified view of Egypt’s economic landscape. By treating the informal economy as an aberration — a deviation from the norm that can be corrected — the reform measures the government has pursued over the years have produced meager results.

The traditional wisdom: incentivize registration

In contrast to countries where authorities chase after informal enterprises to collect taxes from them, the Egyptian government has taken on a less interventionist approach by introducing economic incentives aimed at attracting businesses to register and join the formal sector.

In an interview in November, Saeed said that the tactic of simplifying bureaucratic requirements and reducing registration costs to encourage informal businesses to join the formal economy is one that has been used in countries around the world.

The primary factor that discourages informal businesses from registering is the costs and interest payments that come with joining the formal sector, says Alia al-Mahdy, an economics professor at the University of Cairo who has researched the issue.

The informal economy represents from 27% to 35% of Egypt’s GDP, according to common estimates, yet government officials believe it may actually constitute up to 60% of the economy. Mahdy says estimating the size of the informal economy is complex, which leads to the wide disparity in estimates. She calculates that there are approximately eight to nine million informal workers and employees currently working in Egypt.

Al-Mahdy, along with other researchers, met with a number of tradesmen who own unregistered workshops between 2003 and 2004. The proprietors said they wanted to legalize their businesses, because they were frequently extorted and forced to pay bribes to various officials.

But the process of legalization is a complex one that involves wading through a maze of red tape, with bureaucratic requirements spread out among a number of state entities, including the Labor Bureau, the Tax Authority, and local authorities, among others.

There is also the cost of legalization. Al-Mahdy says that at the end of the day, informal business owners are “rational and crunch the numbers: If a bribe is LE 3,000 and legalizing costs LE 10,000, the answer is clear.”

In addition to the costs of registering, there are also recurring annual costs to consider. “Applying for commercial electricity alone costs more than LE 11,000, and the cost of a business feasibility plan is around LE 25,000. Those two requirements alone cost LE 35,000,” Alia says. “It is natural that the business owner would opt to work from home and steal the electricity.”

Legalization costs are relatively higher for smaller enterprises, says Ragui Assaad, a professor at the Humphrey School of Public Affairs at the University of Minnesota. “There is a close relationship between the size of the enterprise and the likelihood it remains informal,” Assad says.

According to 2010 estimates, the vast majority — around 80% — of  all micro and small businesses are informal.

Mahdy and Assaad agree that curbing taxes for micro and small enterprises is a necessary step, but the simplification of the legalization process may be even more important. For example, simplifying taxes so business owners can accurately calculate how much they need to pay on an annual basis is key, Mahdy says. This is particularly true because the nature of the work of many of these businesses is often irregular, so being able to assess the annual tax expense in advance would act as a reassurance.

Most countries have introduced a lump-sum tax, which is a fixed amount payable regardless of the circumstances, Mahdy says. Egypt has succeeded in easing the registration process, as noted in the World Bank’s “Ease of Doing Business” report for 2018. Yet Assaad says more needs to be done, including reducing the cost of registration even further.

These types of measures are touted by international financial institutions, such as the World Bank and the International Monetary Fund. However, this type of approach has come under criticism for being detached from the realities of the informal economy. It is more complex than a simple calculation of profit and loss.

To register or not to register?

Ahmed Bakry owns a small coffee shop in Mansoura, a village in the Delta some 130 kilometers north of Cairo. He is also proud to belong to the formal sector; all his documents are “valid,” he says.

“I have commercial registration, a tax card and a license,” Bakry says. He insists the legalization process was quick as all the bureaus had representatives inside the headquarters of the Chamber of Commerce in Mansoura.

Unlike most micro and small business owners, Bakry was able to receive a loan from a lending institution to launch his business. Apart from the loan, Bakry also had access to other, non-financial resources that are essential to the management of a commercial project.

Bakry says that without his relationships with local police officers and acquaintances in a number of government offices, he would have had to spend a lot of money on electricity and other utilities. “Neither the registered nor the unregistered are comfortable,” Bakry says. “Those who have connections are the ones who are comfortable.”

Unlike Bakry, others choose not to register, regardless of how simplified the process is or how great the tax incentives are.

Helen Labib, a housewife in her twenties, sells desserts online through a Facebook page after her friends encouraged her to turn her baking skills into a profit-making business. Helen borrowed some money from her mother, surfed the internet and made some phone calls before buying baking equipment from China. Months later, Helen had a steady flow of orders for her cakes and biscuits for birthdays and other occasions.

When asked whether she would open a registered bakery, Labib told Mada Masr that dealing with the official sector is difficult and that she prefers the flexibility of her work. Despite her desire to expand her business, Helen is not motivated to go through the registration process. Instead she tries to grow by displaying her products in busy areas.

Labib’s case reflects the conclusions of several research papers that explore the layered factors within informal economies. In 1997, Iranian American sociologist Asef Bayat wrote a famous paper on the concept of ease of registration, which found that business owners seek independence from the formal system for reasons that have deeper, more complicated roots than simply bureaucracy and net profit.

“The disenfranchised express a deep desire to live an informal life, to run their own affairs without involving the authorities or other modern formal institutions,” Bayat said in his paper. He adds that informal people benefit from being outside the system since modern state institutions are unable to meet their needs.

Although Bayat was mainly referring to marginalized groups, this attitude — of which Labib’s case is an example — is common in the middle class and above. Aside from financial concerns, informal work offers its own privileges, such as complete control and flexibility with business decisions.

Bayat argues that informality allows the poor to make use of public resources, such as land or sidewalks, that would be difficult to access in the formal sector.

In the meantime, the state continuously announces initiatives to facilitate access to these resources, either by providing workspaces or financing. So have these initiatives changed the preferences of informal entrepreneurs?

Who receives state benefits?

One of the projects highlighted in the media in recent months as a way to encourage informal businesses to legalize has been Damietta Furniture City. The project is built on 330 feddans of land on the outskirts of the coastal city of Damietta and has around 1,400 industrial units that have access to high-tech equipment to produce furniture and exhibition halls in which to sell it. The project essentially has all the elements furniture manufacturers would want to come set up shop and help revive an industry that Damietta was once famous for.

But furniture workshop owners complained that prices were too high, the workspaces too small, and that the location is too far from the city center.

A workshop owner in Damietta, Mohamed Nabil, told Mada Masr that those who will get units in the project are the owners of large factories represented in the Chamber of Commerce, who will then turn around and sell them to businesses that can afford them. Most small craftsmen in Damietta, like himself, will not benefit, Nabil says.

Whether Nabil’s skepticism about projects like Damietta Furniture City is founded or not, there is a common belief that only a few privileged and connected players stand to benefit from registering in such endeavors. This notion is an important one when considering obstacles to the integration of the informal economy.

In the end, Nabil will not move his workshop, as it is located in the same building as his apartment; he has the flexibility to easily manage it or have a neighborhood acquaintance help out, and the costs are low.

Nabil’s belief in the need for powerful connections and Bakry’s experience as a coffee shop owner indicate that working under the umbrella of the formal economy does not eradicate the need for informal solutions, a phenomenon several research papers conclude in their findings.

The economy is a convoluted mix of formal and informal practices; some contexts are more formal than others, but there is no clear dividing line between the two. In order to tackle the issue, the state must recognize that these two economies are not neatly divided into separate phenomena but are rather always intertwined to varying degrees.

From Europe to Wekalet el-Balah: The overlap of formality and informality

If you walk through the neighborhood of Bulaq al-Dakrour, near downtown Cairo, sooner or later you will come across a mass of clothing stalls in the streets that make up Wekalet el-Balah, Egypt’s largest secondhand clothing market.

The overlap between formality and informality is most apparent in Wekalet el-Balah market, according to anthropologist Omnia Khalil, who has traced the journey of second hand clothes on sale in Wekalet el-Balah from flea markets in Belgium, Italy, France and Switzerland.

In a working paper, Khalil identified the formal and informal stops in the journey the clothes make from Europe to Port Said, and then finally to Cairo. “There are, for example, port clearance fees and money paid to customs, and rent paid for the clothing shops in the market and real estate taxes paid. All of this is part of what is called the formal aspect of the economy,” she says. On the other hand, “there are the bribes paid in the ports to reduce customs, and the hundreds of informal laborers who wash, iron and organize the clothes based on type and season. There are the salespeople who sell on the streets of the market and the kickbacks paid to avoid hassle from the police.”

The secondhand clothes trade epitomizes the interdependence between formal and informal economic operations, where one system cannot exist without the other. Traditional schools of thought that focus on the duality of formality and informality ignore this very interdependence. Every Egyptian economist is aware that the majority of the labor force within the formal sector is made up of unregistered workers.

Yet Khalil thinks it is reductive to look at the issue comprehensively and prefers studying each case separately.

“The political economy of secondhand clothes in Egypt originates from a phase in Egypt’s contemporary history when the state adopted free market policies and, as a result, traders in Bulaq were awarded trade licenses for these imported secondhand clothes,” Khalil says. “The licenses were then inherited by the sons. This development was entangled with the political, social and legal infrastructure in Egypt to produce what we see today in Wekalet el-Balah.”

Reducing the issue to simply passing legislation that facilitates registration and trying to lure unregistered enterprises with incentives won’t work, precisely because the two economies are entangled and interdependent.

Many researchers have criticized aspects of the formal and informal economies for their role in reproducing the difficult working conditions of ordinary people who fall into the “informal” category.

In a 2015 paper titled ‘understanding informality’, sociology professor Lila Grunwald explains that the main criticism of this dichotomy is that it does not recognize the living conditions of those who work informally, and that they resort to this work out of necessity. Without this informality these people would be unable to access an income and security, even though the income is unstable and the security is temporary.

The binary approach helps create a perception that people working in the informal sector have deviated from some “natural” path. Accordingly, informality becomes a stigma which allows for people in more privileged positions to use force or incentives in their dealings with them.

“The issue of trying to merge the informal with the formal is that it’s an artificial construct, and is phrased in a legal and procedural manner that does not look at reality,” says Amr Adly, a political economist at the American University in Cairo.

Why go after the street vendor?

“The most distinguishing feature of the informal economy is that most of its activities are micro transactions, with low-value products being exchanged for self-employment,” says Adly. He adds that the low value of these goods renders their revenues insignificant for the government.

Official statistics show that most of the businesses in Egypt are micro and small enterprises. For example, in Cairo, 94.28% of enterprises employ a range of 1 to 5 people, and 23% of those employ just one person, according to the 2017 population count.

In Adly’s view, informality is a symptom of economic backwardness, not one of its causes. He says legalization comes naturally as small enterprises expand and increasingly need the state to play a role in regulating business interactions with parties outside of personal circles, which typically characterize their base, as well as to provide financing for growth.

Adly says one of the main reasons the state wants to legalize these enterprises is to tax them. “The traditional method of tax collection is through indirect taxes of small enterprises and direct taxes of larger enterprises that generate high revenues,” he says.

“As for pursuing a street vendor to collect five pounds, it’s laughable.”