Small Enterprises Under Liberalization

This study incorporates data from comparable surveys across five African countries - Ghana, Malawi, Mali, Senegal, and Tanzania - to analyze how small and micro enterprises have been positively and negatively affected by policy liberalization schemes. Som

Abstracts of papers presented during a seminar.

Study conducted at Dindigul and Madurai districts of Tamil Nadu, India.

"A well developed financial system enhances competition in the industrial sector by allowing easier entry. The impact varies across industries, however. For some, small changes in financial development quickly induce entry and dissipate incumbents' rents, generating strong incentives to oppose improvement of the financial system. In other sectors incumbents may even benefit from increased availability of external funds. The relative strength of promoters and opponents determines the political equilibrium level of financial system development. This may be perturbed by the effect of trade liberalization in the strength of each group. Using a sample of 41 trade liberalizers Braun and Raddatz conduct an event study and show that the change in the strength of promoters vis--̉vis opponents is a very good predictor of subsequent financial development. The result is not driven by changes in demand for external funds, or by the success of the trade policy. The relationship is mediated by policy reforms, the kind that induces competition in the financial sector, in particular. Real effects follow not so much from capital deepening but mainly through improved allocation. The effect is stronger in countries with high levels of governance, suggesting that incumbents resort to this costly but more subtle way of restricting entry where it is difficult to obtain more blatant forms of anti-competitive measures from politicians. This paper--a product of the Investment and Growth Team, Development Research Group--is part of a larger effort in the group to understand the relation between finance and the macroeconomy"--World Bank web site.

Trade liberalization in Latin America has substantially altered business opportunities and economic development in the region. As barriers to competing inputs have come down and foreign investment in the region has gone up, small, domestic firms have struggled to stay afloat. Many small businesses have survived by skirting the legal requirements to operate a business, including registration and taxation, thereby bringing their operating costs just low enough to earn a profit. As trade liberalization continues to reduce barriers to foreign competition, and domestic firms face increasing pressure to compete, these informal firms have come under increasing pressure to legitimize or cease operations. With strong pressure from the tax-paying business community, international organizations, and foreign industry, many countries have increasingly begun formalization programs that target informality as a reason for slow growth in the face of open trade. In this thesis, I pose a straightforward question: Is formalization good for economic development? This question opens the door to an evaluation of the underlying cause of informality, the basis for the push for formalization, and an assessment of the likely result of such a process. Formalization attempts to remedy the problems of low productivity and aversion to compliance with the law through economic incentives, such as tax discounts and streamlined business procedures that are intended to help firms make their way into the formal marketplace. However, in many developing countries, the informal economy is an economic consequence of trade pressures, and a legal consequence of a failed social contract between the state and its small business community. In its current iteration, the formalization process is coupling the tools used to improve business practices and procedures with the legalization process for millions of existing informal firms. By doing so, the state is ignoring the dual legal and economic framework within which informal firms operate. Improvements in business processes are good for business and can help existing and intending formal firms succeed. But these are much less likely to overcome the deep-rooted failure of the state to address the needs of the bulk of the citizenry. I argue that an effective formalization process must 1) address the terms of the social contract between the state and its informal economy, and; 2) make improvements in social programs to protect the health, safety and prosperity of existing informal firm operators. It is my contention that informal firms have largely rejected the state's rule of law contract because the firms are unwilling to cede their freedom to operate an informal business in exchange for state protection of property or rights that they rarely possess. As such, in order to not only reduce the growth of the informal economy, but also to improve the rule of law, the state must take aggressive steps to reform their arrangement with the informal economy by building dynamic linkages between formal and informal legal and economic frameworks. An immediate step that states should take, I argue, is to implement programs that remove some hazards of operating an informal business by enforcing restrictions on the use of certain public space, providing safety equipment to street-based firms, and investing in improvements in the design of public space. This modified formalization approach is not intended to rapidly eliminate the informal economy. Rather, it is aimed at improving the economic development of the state through an enabling, rather than a punitive approach. This modified approach will increase the value of the social contract and rule of law to informal firms; illuminate a pathway to voluntary legalization; protect individuals operating informal firms, and; improve access to education, training, and social services for all small firms. Capitalizing on the contributions made by the informal economy to a state's economic development may help to turn a destructive process into a growth opportunity.