Dossier

The informal economy: the ups and downs for agriculture

The informal sector provides income and jobs for the most vulnerable populations in developing countries and, if gradually formalised, has potential to become a major lever for growth and development.

An estimated 43% of Africa’s population gain income from informal cross-border trade © Arne Hoel/World Bank
An estimated 43% of Africa’s population gain income from informal cross-border trade © Arne Hoel/World Bank

Thursday, 30 November 2017

The informal food sector – from the field to the market – constitutes a large proportion of agricultural trade in developing countries. To harness the potential of this vast section of the economy, policymakers and the private sector must facilitate stakeholders’ access to training, financing and technological innovations, whilst also taking their difficulties into account.

Sub-Saharan Africa is hampered by chronic malnutrition, and access to food is highly dependent on cross-border markets. It is estimated that 75% of intra-regional trade is informal, a substantial share of which constitutes staple foods. Thus, informal trade has a direct impact on food security and according to an International Monetary Fund (IMF) report, it represents “a safety net, providing employment and income to a large and growing working-age population.”

In 2012, an African Development Bank (AfDB) brief estimated that 43% of the African population gained income via informal cross-border trade (ICBT). “ICBT can have positive macroeconomic and social ramifications such as food security and income creation, particularly for rural populations, who would otherwise suffer from social exclusion,” the AfDB brief explains. “If properly harnessed, ICBT has the potential to support Africa’s ongoing efforts at poverty alleviation.”

However, informal trade often results in substantial loss of revenue for states, so the key question is how can countries take advantage of the informal economy to create jobs, and support growth and sustainable development?

Informal yet inclusive

According to FAO, the informal economy, “includes legitimately-produced goods and services that do not necessarily follow formal processes such as standards regulations, business registration or operational licenses.” Informal trade is not necessarily illegal, but it is also not really legal, and yet it is vital to developing country economies.

The informal sector generates up to 90% of employment opportunities in some sub-Saharan African countries, while also accounting for a significant share of GDP. The sector often supports the most vulnerable people in society, including women, youth and the rural poor, as underscored by an International Institute for Environment and Development (IIED) report. AfDB also estimates that around 60% of informal traders at the borders of West and Central African countries are women. The IMF report points out that similar trends prevail in the Caribbean, where the informal sector also accounts for a substantial share of national GDPs (see box, Formalising informal agricultural trade in the Caribbean).

In developing countries, the informal economy tends to remain very pervasive. Many factors are responsible for this trend, including: lack of trade facilitation, inadequate border infrastructure, limited access to finance and market information, corruption and insecurity, limited knowledge, education and business management skills. Moreover, “it is the inclusive nature of the informal food economy that explains its resilience,” says Bill Vorley of IIED. Low-income consumers, which often depend on little cash, can easily find staple and fresh foods, animal products, processed and prepared foods at affordable prices.

Interactions with the formal economy

The problem, however, is that “informality means that there is no access to the best production technology, financing structures or innovation capacity building instruments. This has all slowed growth,” says Ousmane Badiane, director for Africa at the International Food Policy Research Institute. Most agricultural processing companies are small, home-based and located far from technological innovation centres. Moreover, no banks will issue loans to unlicensed traders without a clearly outlined development plan. “Informality creates jobs and wealth, but at a rate that is not sufficient to overcome poverty,” concludes Badiane.

Rural areas are nevertheless increasingly linked to national and international markets. In its report, IIED mentions that “the traditional informal practices of rural communities now interface with the rules and regulations of urban and global markets.” Long-standing practices and formal rules form a resilient rural informal economy that runs parallel to the formal economy, interacting with it along the value chain. This is the case for the groundnut, coffee and cotton sectors, for instance, where smallholders sell their crops to duly licensed processing companies, often via intermediaries or cooperatives.

Informal trade is most intense at country borders (see Spore Field Report, Realising the potential of cross-border trade), as a report by TradeMark East Africa – a non-profit organisation that aims to promote and structure trade in Eastern Africa – points out. At the Kenya-Uganda border, the city of Busia attracts diverse traders, like Harriet Nafula, a Kenyan farmer who has a stall along the main road. She sells pawpaw fruit and pineapples that she buys wholesale and ripens at home. She also grows maize and bananas, which she sells at her farm. She has 10 regular customers, living about 100 km from Busia, who place and pay for their orders by mobile phone. She then ships them their fruit and seed purchases by minibus. Further south, the cities of Mwami and Mchinji, located between Malawi and Zambia, jointly constitute one of the most active informal trade hubs in Southern Africa. Here, the Common Market for Eastern and Southern Africa (COMESA) has determined that informal trade amounts to €2.4 million per month, compared to €1.35 million for formal trade.

The road to progress

Another major problem is the difference in productivity between informal and formal businesses. On average, based on real output per employee, the productivity of informal firms is only 25% of small formal companies and 19% of medium-sized formal firms. The IMF explains that, “This likely reflects a lower level of physical capital and skill levels of workers.” Moreover, according to the already quoted FAO report, working in the informal sector often deprives employees of their rights, such as social and health protection, freedom of organisation and participation in the social dialogue on the transition to a formal economy.

Nevertheless, “Great progress [in formalising the food sector] has been made,” says Badiane. “Concerning millet in Senegal, for example, in the 1970s you had to live in the vicinity of a millet cropping area to have access to this cereal. Nowadays, in Washington I can buy ready-to-cook millet-based products from Senegal. It’s the same story for Nigerian cassava. Much of the African agriculture sector is becoming formalised.” According to Badiane, who also underlines that access to financing and training is essential, “the bottleneck [in formalising agricultural trade] concerns access to innovation technology for processing, packaging, production procedures and the creation of new products.”

However, better access to innovations and technology are often now facilitated by the private sector, which has been encouraged to invest in agricultural value chains due to social transformations that have increased demand for high quality products. “Formalisation is accelerating because the distribution channels are changing,” says Badiane. “There are a lot of mini-supermarkets in urban areas that promote the processing and distribution of conventional agricultural products. Another interesting phenomenon is the rise of the African middle class, which, as affluence increases, is boosting the demand for traditional processed and improved products. This, in turn, stimulates the processing, packaging and branding sectors, [for example] with regard to white maize in West Africa, cassava in Nigeria and millet in Senegal.”

Thanks to the emergence of a strong middle class and the construction of numerous shopping malls, the Kenyan retail sector has become the second most formalised on the continent. In Ethiopia, the return of a large diaspora community and the formation of a somewhat growing middle class have boosted the local coffee roasting market – the capital now counts over 100 companies against a handful only a few decades ago. In a country where people are used to roasting coffee themselves at home and the best quality beans are exported, this is a significant change.

Technology’s role

Transformation of the informal sector can also occur through technological innovations. In South Africa, Mastercard and a local technological innovation firm, Spazapp, are offering small staple food shops the possibility of connecting to formal markets and digital payment systems through a mobile phone app. The Spazapp platform gives traders collective bargaining power to order a large variety of products at competitive prices, which they can pay for via their mobile phones using Mastercard’s digital wallet, Masterpass. The innovation has already directly linked 4,500 informal traders to leading consumer brands like Unilever and Tiger Brands.

A similar initiative, launched in Kenya in 2014 by the Twinga Foods start-up, has already proven beneficial for 2,600 informal traders. The app enables traders to access supplies quickly and reliably, while saving time by having traceable goods delivered. Meanwhile, producers can avoid intermediaries, as well as receive market information and quick payments, overcoming many uncertainties inherent to the informal sector.

A measured approach

Rather than deploring informality, authorities are also being encouraged to facilitate a gradual transition to formal trade, as in the International Labour Organization’s recommendation 204 adopted in 2015. This primarily involves simplifying customs and tax procedures. COMESA and the East African Community have recently introduced a Simplified Trade Regime aimed at streamlining trade by reducing taxes and simplifying bureaucratic procedures. However, these legislative instruments will only have an impact on the informal sector if stakeholders understand the mechanisms. FAO and the NGO, Catholic Relief Services, have organised information sessions at the Rwanda-Democratic Republic of Congo border, where women cooperative members are able to learn about customs taxation from customs officials and government representatives. In Rwanda, a research paper revealed that once they are educated and trained, people often turn to the formal sector. Conversely, fiscal and legislative sanctions for informal activities usually have negative impacts.

In addition, as a priority, trust in institutions must be restored in order to formalise the economy. “Legality alone will never persuade enterprises of the benefits of formalising. Authorities may have to overcome deep distrust of state policy, as a force for harassment and exclusion of informal enterprises,” states Vorley. The Mouride ethnic group in The Gambia and Senegal, the Yoruba in Benin and Nigeria, the Burji in Kenya and Ethiopia, and the Lugbara in Congo and Uganda have all created strong informal trade networks that facilitate the dissemination of market information, ensure contract enforcement, and enable the provision of credit and rapid transfer of funds at a low cost, which the authorities failed to provide.

Creating the right environment

For governments, fostering the right business environment for formal trade is key. For example, providing land titles can improve access to credit and have a positive economic impact as in Ethiopia, where a government programme focused on land certification has improved tenure security, investment and the supply of land to the rental market. Additionally, in supporting smallholder farmers to organise into cooperatives, or similar formal groups, governments can help them to access finances more easily. Being members of such farmer organisations also reinforces farmers’ bargaining power and ability to agree formal contracts that provide greater price security, embed quality standards and encourage investment.

In Kenya, where the informal dairy sector generates 70% of the 40,000 marketing and processing jobs and 86% of all milk is sold in informal markets, a joint IIED and International Livestock Research Institute study showed that adopting a progressive approach to transforming the sector has paid off, at least initially. Instead of sanctioning stakeholders in the informal dairy sector, the government has offered them the opportunity to be trained on formal production practices and quality control. The study ascertained that, “Training and certifying informal market traders in Kenya has had sustained benefits: helping the government to protect public health, supporting the livelihoods of producers and traders and increasing the availability of milk to nutritionally insecure households.” At the same time, producers are earning a higher income and they have greater bargaining power to get the best deals.

Such initiatives demonstrate that it is essential to address the needs and constraints of everyday agricultural stakeholders, who often do not have any other option but to trade informally, in order to transform the informal economy into a major lever for growth and development. As Vorley outlines, “Recognition of the informal food economy and its stakeholders is a key step [towards formalisation], as are meetings with farmers, traders, processors and sellers in their markets.”

Formalising informal agricultural trade in the Caribbean

Since the 2007 global financial crisis, the slowing down of Caribbean economies has resulted in a marked expansion in the informal sector and a rise in small and medium-sized enterprises. The more prominent the agriculture sector, the larger the informal economy in the region. With an estimated tax burden of 43.2%, and the importance of agricultural raw material and food products, which make up 30.7% of total exports, Dominica has a large informal sector. However, it is the only market in the Caribbean where ‘hucksters’ (independent traders) have formed a formal trade association.

Hucksters are the biggest exporters of agricultural products within the Caribbean Community and Common Market. For example, hucksters are the main buyers of fresh produce in Barbados, and of fruit and root crops in Grenada and Saint Vincent and the Grenadines. These entrepreneurs are very price sensitive; usually operating in the informal sector, hucksters are able to offer lower than wholesale prices and tend to compete with the state marketing boards in each country. To maintain good business, hucksters’ buying criteria is based on quality, price and availability.

In Dominica, formalisation of the huckster’s trade has helped its members overcome difficulties related to market access, creating economies of scale, supply and financing, as well as regulatory and bureaucratic challenges. The Dominica Hucksters Association (DHA) Limited comprises of approximately 120 members, who benefit from a range of services to facilitate formal exporting activities, including training in exporting fresh produce, and support with document preparation and market research on regional and international markets. The main commodities exported by the DHA are banana, plantain, sweet potato, dasheen, tannia, pineapple and passion fruit. The potential for increased business growth through a formal bargaining body has also had positive effects on the local economy through income generation and the creation of employment.

Arnold Babwah, a management consultant who produced a Market Study for Fresh Produce in 2016, which included a review of the DHA, states that, unlike many hucksters operating in the informal economy, “Members of the DHA tend to pay a reasonable price to farmers, usually higher than the wholesale price, as they want to maintain long lasting relationships with farmers in order to sustain their business.”

Natalie Dookie

Vincent Defait

Other dossiers

The Technical Centre for Agricultural and Rural Cooperation (CTA) is a joint international institution of the African, Caribbean and Pacific (ACP) Group of States and the European Union (EU). CTA operates under the framework of the Cotonou Agreement and is funded by the EU.