poverty and the informal economy

8/7/2019 Poverty and the Informal Economy

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Poverty and the Informal Economy

Human development and human rights share a common vision and purpose: tosecure the freedom, well being and dignity of humanity. Human development isas essential for human rights as the latter is for the former. Historical evidence

suggests that the more civilised societies were those that gave a higher priorityto both, for example, the Greek, the Roman and the enlightened years of earlyIslam. The freedom from want is perhaps the one inalienable right of humanitywhich stands between dignity and indignity and which must be mitigated againstby both state and individuals. The first informal recognition of this lies in thealms-giving encouraged by all religions and beliefs, and was formally codified byIslam throughzakatand ushr(a form of redistributing wealth and agriculturalincome respectively) as a religious duty [the Quran]. In fact, this was appliedwith such zeal, and the partnership between state and individual was so effectivethat in the days of Caliph Umar Farooq (634-644 AD) the collections fromzakatand ushrcould not be distributed as no one could qualify as a mustaheq(deserving poor). The state system was unfortunately allowed to lapse.

Individual and private efforts to mitigate poverty and endow the poor with socialcapital, however, continued throughout the Muslim comity.

The poor are generally perceived to be those who are deprived of opportunity

and poverty is explained by individual circumstances and/or characteristics of

poor people. The poor are those who face deprivation of common necessities

that determine the quality of life, including food, clothing, shelter and safe

drinking water. They also face deprivation of opportunities to learn, to obtain

better employment to escape poverty, and/or to enjoy the respect of fellow

citizens. Stated differently, to be poor is to be deprived of those goods and

services and pleasures which others around us take for granted. Poverty isperceived as the state of being poor.

The lessons from history clearly establish that for improving the socialendowment of the poor both the state and the individual are key players; moneyis a necessary requirement; good governance is critical to success and theparticipation of each component of society as a whole ensures sustainability andcontinued benefits beyond the initial attempts to mitigate the impact of poverty.In other words decentralisation is a key element to improve the lot of the people,particularly the poor and the disenfranchised. This is so because it thecommunity which has much greater insights into who are poor and who aredisenfranchised.

Governance is generally conceived of as the exercise of economic, political andadministrative authority to improve the quality of life of the people. It is acontinuing process where divergent opinions and desires are satisfied throughcompromise and tolerance in a spirit of cooperative action for the mutual benefitof the larger whole. It has three dimensions: one, the political regime; two, thesystems and procedures for exercising authority; and three, the capacity ofgovernments.

The basic objective of good governance is to improve the quality of life of people,to ensure that their needs are met equitably and that disparities in income are

reduced over time and is best attained through the effective participation ofpeople, that is through decentralising the apparatus of the state to the closest


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level to people, namely local governments. The incidence of poverty is onemeasure of whether governance in any nation or state is good or bad. Povertyhas been rising over time in Pakistan and is currently estimated to include about44 percent of the population. While the mass of the numbers are in the ruralareas, extreme poverty is more evident in the urban areas. This is largelybecause the poor in the rural areas continue to have food security which isdenied to the urban poor.

Politics is about the creation and distribution of power, be it within organisations,tribes, communities or society at large. Governance is the mechanism whichcontrols the relationship between the two extremesthe governed and thegovernors. The political process lies at the core of governance and this can besaid to be efficient only if elections are free and fair; the elected areaccountable, authority is divided between the legislature, the bureaucracy andthe judiciary; and, power is decentralised.

Poverty is an outcome of the interaction of economic, social, legal and political

processes mediated through a range of institutions. By removing these barriersto poverty reduction, the state can help to empower the poor to improve theirlives. The interaction between the quality of governance and democracy, therule of law and the extent of devolution, decentralisation and autonomydetermine the success of state institutions in being "pro-poor." In essence,therefore, there are four ingredients in the relationship between governance andpoverty: one, democracy, two, the rule of law, three, bureaucratic performance,and four,pro-poor institutions.

In any society the key dimensions to poverty are both being unheard andpowerless. Democracy requires one, regular and peaceful elections; two, highlyinclusive participation by all; and three, freedom of expression, of the press, toform and join organisations, and to information. It is argued that democracy willreduce these barriers to poverty eradication through empowerment. However,this is not necessarily achieved, principally because the poor are excluded fromaccess due the lack of education, knowledge, opportunity, economic power,information, etc. Unless elected to local office the likelihood of the poor havingaccess to the elected is non-existent. Thus the poor need a direct voice in theinterventions that affect them on a day to day level, and to build up their assetsto prevent their exclusion. On the other hand, democracies appear to be morefavourable for the income, health, and education dimensions of poverty. Further,a free press can create awareness in the public and increase transparency andaccountability in governance. This in turn helps in reducing corruption, reduces

the arbitrary use of authority and increases the potential for meeting the needsof the poor. All of which combined contribute to higher rates of growth.

The debate on the causes, effects, extent of, and the best ways to measurepoverty, directly influences the design and implementation of poverty-reductionprogrammes. At the official level in Pakistan poverty reduction programmeshave included the distribution of Zakat funds collected by the FederalGovernment through local Zakat Committees, the Distribution of Bait-ul-Maalfunds through identification of the recipients by the local councils, the variousversions of public works programmes delivered through the local governments,the distribution of micro-credit through local NGOs, and the latest experiment isthrough food stamps and higher cash transfers. However, the most extensive

support to the poor is provided by cash transfers privately as Zakat, Khairat and


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Sadaqa by the wealthier segments of society and through employment in theinformal sector of the economy.

The latest studies on the informal economy estimate that Pakistans informal

economy is believed to have grown to be more than half the formal economy

which yields a GDP of $166 billion. One report says that it has reached suchproportions that it was upsetting public welfare plans. The report puts its size at

$83 billion and that it could yield the national exchequer revenue of $8 billion if

taxed even at 10 per cent. But there is a belief that the countrys parallel

economy has already touched $100 billion. To determine the size of the informal

economy is problematic simply because there is nothing on paper. According to

an assessment, the underground economy expanded at the rate of 9 percent

annually between 1977 and 2000. Since then it is estimated to have grown by

nearly 11 percent annually. These rates are a much higher rate than the formal

economy.

The informal economy helps its sections make easy profits since wages are

below minimum wages prescribed by law. The informal economy grows along

with corruption, speed money, smuggling, narcotics, and tax evasion as these

are all cash based. Only recently, hoarders and speculators of staple food

commodities like rice and wheat were able to make a killing by their covert

activities with the active connivance of officials, both elected and appointed.

No government has shown nerves to tackle this problem. Every government at

some stage initially takes a serious view of the situation but then decides to offer

incentives to whiten the black money/assets. The informal economy (which also

includes the black economy) is, of course, a global phenomenon. TheEconomist, London, for instance, estimated that in 1998 the worlds black

economy was about equal to the output of the United States.

While most of the underground economy elsewhere in the world revolves around

criminal or illegal activities, the major contributors to the black economy in

Pakistan are legal businesses and the government. Legal businesses controlled

by the government, government expenditures and taxes have also been the

major source of black-money creation. For instance, no real-estate deal in the

country is done without the involvement of at least 40 per cent unaccounted-for

money, and a large portion of the billions of dollars in foreign exchange inflowsthat Pakistan sees every year is actually the returning black money that went out

of the country in the high-tax regime before liberalisation began.

One study shows that the informal economy is not just the unregistered street

vendors and tiny businesses that form the backbone of marketplaces in Asia and

other emerging markets. It includes many established companies, often

employing hundreds of people, in industries as diverse as retail, construction,

consumer electronics, software, pharmaceuticals and even steel production. In

India, Pakistan, Indonesia and the Philippines, as much as 70% of the non-

agricultural workforce is employed in informal businesses, thereby contributing

to minimising poverty in the cities and towns.


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Despite the prevalence of the informal economy, policymakers in Pakistan show

surprisingly little concern. Governments argue that it helps relieve urban

employment tensions and will recede naturally as the formal economy develops.

However prima facie evidence suggests that informal companies themselves will

grow, modernise, and become law-abiding if given some help.

The reasons why informal economies grow and keep growing are not hard to

uncover: high corporate tax rates and the enormous cost of doing business

legally. In Pakistan there are more than two dozen agencies of government

impeding legal business activity. Only the police impact on the informal

economy. All in all, legal businesses face administrative costs three times as

high as their counterparts in developed economies. No wonder so many choose

to operate in the gray.

The costs imposed by the informal economy are not limited to the hundreds of

millions in foregone tax receipts; more damaging is its pernicious effect oneconomic growth and productivity. The unearned cost advantage informal

businesses enjoy from ignoring taxes and regulatory obligations allows them to

undercut prices of more productive competitors and stay in business, despite

very low productivity. Informal apparel makers in Pakistan have an estimated

25% cost advantage over their law-abiding competitors by not paying taxes or

adhering to labour laws.

While it may be argued that reducing the size of the informal sector would

enable government to widen the tax base and thereby provide money for long-

term programmes for sustained poverty reduction, the proponents for theinformal sector state that this is not true. They point simultaneously to the

substantial increase in tax revenues and also to the increasing levels of poverty

caused by this. They argue that reduction in taxes alone will not induce the

reduction of the formal sector.

It can be argued that assisting the informal sector to contribute more to poverty

reduction would require the legislators to:

Encourage the government to reduce that tax rate of small businesses to

less than a quarter of the existing corporate rate,

Improve the tax-paying culture by taxing all segments of the economy, Streamline regulatory procedures,

Simplify the tax laws, for instance giving small businesses the option of

calculating taxes based on physical characteristics, such as a store's

square footage, rather than reported revenue, which is difficult to verify.

poverty and the informal economy

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