The South African government has embarked on an ambitious drive to support small businesses in the informal sector. But if it really wants to reduce the reliance on the informal sector, it's aim should be to create educated entrepreneurs wherever they may be, argues new research.
Last month the Presidential Business Working Group announced that the government would launch a fund to back informal-sector enterprises.
This, while also last month David Makhura, the premier of Gauteng (the country's richest province) told delegates at a summit that his government plans to create a state bank that will support the province's township economy.
This is in line with the province's plan in place since 2010 to revive townships (which in South Africa are home to 38% of the country’s working-age population, but have almost 60% of its unemployed) through the provision of factory parks for light-industry and funding for micro enterprises
Meanwhile the Small Business Development department has begun rolling out part of an informal support strategy launched earlier this year by the Department of Trade and Industry (see here for my earlier story on this).
The plan includes the provision of grants of up to R50,000 to unregistered firms to update machinery and buy stock, while a second part includes a partnership with municipalities to update infrastructure. In addition a pilot training project is expected to benefit 1,000 traders in rural areas and townships.
The strategy appears to have come in reaction to the increase in foreign traders and shopping centres in townships, which have seen local micro enterprises struggling to compete. But will throwing money at the informal sector help more firms to create more jobs and grow?
Disappointing job creation
The latest survey of employers and self-employed by Statistics SA reveals that the informal sector’s contribution to gross domestic product (GDP) has remained at about five percent from 2001 to 2013. Its contribution to employment has declined by one percentage point, to about 16%, over the same period.
By employment share this is far larger than Malaysia (10%) and slightly smaller than Brazil's informal sector (20%). But it is a far off Mexico where half of all workers are employed in the informal sector.
At present informal-sector firms create little jobs. Results from Finscope's 2010 SMME survey show that two in five of the most sophisticated small firms (57% of whose owners have a university or college qualification) employ five or more people.
In contrast 93% of the least sophisticated (where just one percent have a tertiary qualification) employ no one other than the owner. More educated entrepreneurs generally create more jobs.
More educated entrepreneurs
In a working paper released in June, Rafael La Porta of Dartmouth University and Andrei Shleifer of Harvard University argue that large informal sectors linger in some countries not mainly because of an under supply of educated workers, but because of an under supply of educated entrepreneurs.
While tax avoidance and regulations encourage firms to remain informal, La Porta and Shleifer estimate that many informal firms are simply too unproductive to survive in the formal economy. Reducing registration costs would neither generate a large shift into the formal economy or boost growth, they say.
They add that research shows that while micro-finance helps informal entrepreneurs a bit, it almost never jump-starts significant growth or gets them to formalise.
They further point to results demonstrating that, typically, nine out of 10 registered firms started out as registered. This means that transitioning from the informal sector to the formal economy is pretty rare. The informal sector usually shrinks following spells of strong economic growth.
Also consistent with this observation, only two percent of informal firms sell their output to large firms (compared to 14% of formal firms, in the World Bank's Enterprise Survey). Informal firms therefore inhabit an economic space of their own, disconnected from the formal space.
"Far from being reservoirs of entrepreneurial energy, they are swamps of backwardness. They allow their owners and employees to survive, but not much more," comment the authors.
They point out that governments should therefore be wary of any policies that impose on informal-sector enterprises any kind of additional costs.
"From this perspective, the policy message for how to grow the formal economy and shrink the informal one is to increase - whether through immigration or education and training - the supply of educated
For South Africa which has one of the world's worst education outcomes, improved education standards at the country's poorest schools and better business support and mentoring for township and rural entrepreneurs may therefore be a better way to reduce the informal sector.
Incubation support could help firms to formalise and create jobs in high numbers.
For example a projection by Awethu Project, which carefully screens and then supports township promising entrepreneurs, is that the R20 million it received from the National Treasury administered Jobs Fund (matched by a R4 million of its own contribution) will help beneficiaries to each create at least three jobs. So far over 500 entrepreneurs have benefited from the funding.
There is some hope that things are moving in the right direction. More incubation centres are cropping up to serve townships, while the Minister of Small Business Development Lindiwe Zulu's department wants to help colleges to role out more centres of entrepreneurship, to bring the number to 20 centres.
Better educated and savy local entrepreneurs might be able to compete better with the thousands of foreign business owners that have begun to dominate township trade.
Stephen Timm writes on small business. To read La Porta and Shleifer's research paper click here.
Stephen Timm is a