the hidden role of informal economy

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Ulla Heinonen Corresponding author: Ulla Heinonen Water Resources Laboratory Helsinki University of Technology - TKK P.O. Box 5200, FIN-02015 TKK, Finland Email: ulla.heinonen@tkk.fi Water Resources Laboratory, Helsinki University of Technology, Finland THE HIDDEN ROLE OF INFORMAL ECONOMY: IS INFORMAL ECONOMY INSIGNIFICANT FOR PHNOM PENH’S DEVELOPMENT? Informal economy is often stated as a temporary phenomenon which diminishes along economic growth. The sector is regularly taken as granted and its role for development is not properly seen. Around 80 percent of the GDP in Cambodia is produced by the informal sector. Informal economy is also important for the country’s urban areas and particularly for the country’s capital city. The economic development of Phnom Penh, the capital, is combined with a growth in its non-agricultural informal sector. At the same time the city’s slum settlements are mushrooming, creating more pressures on the informal sector. As a result, many of the city’s informal workers have become working poors. Without proper protection and legalization of the informal sector, these poor citizens cannot be lifted up from the poverty trap and the sustainable development of the city cannot be achieved. In the 1970s informal sector became a common topic in international development discussions. Informality was identified as a continued existence of traditional activities and production methods that would disappear along with industrialization and modernization (Straub, 2005). The sector was seen marginal for growth and separate from the formal sector. However, later on the informal economy has increased, particularly in the countries where income is not equally distributed, and has become an integrated part of the economy in many countries (Becker, 2004). Thus, the informal economy - the refined definition of the International Labour Organisation (ILO) - could no longer be seen as a temporary phenomenon, or as a phenomenon that straightforwardly decreases with economic growth. In the recent decades the sector has grown around the world and it is currently the largest “economy” in many countries (ILO, 2002). It seems to be that if economic growth is not accompanied by improvements in employment and income distribution, the informal economy does not shrink. Instead, it seems to expand, both in urban and in 1 Introduction to informal economy © 2008 TKK & Heinonen ISBN 978-951-22-9102-1 Kummu, M., Keskinen, M. & Varis, O. (eds.): Modern Myths of the Mekong, pp. 123-132 Water & Development Publications - Helsinki University of Technology AB

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Informal economy is often stated as a temporary phenomenon which diminishes along economic growth. The sector is regularly taken as granted and its role for development is not properly seen. Around 80 percent of the GDP in Cambodia is produced by the informal sector. Informal economy is also important for the country’s urban areas and particularly for the country’s capital city. The economic development of Phnom Penh, the capital, is combined with a growth in its non-agricultural informal sector. At the same time the city’s slum settlements are mushrooming, creating more pressures on the informal sector. As a result, many of the city’s informal workers have become working poors. Without proper protection and legalization of the informal sector, these poor citizens cannot be lifted up from the poverty trap and the sustainable development of the city cannot be achieved. In the 1970s informal sector became a common topic in international development discussions. Informality was identifi ed as a continued existence of traditional activities and production methods that would disappear along with industrialization and modernization (Straub, 2005). The sector was seen marginal for growth and separate from the formal sector. However, later on the informal economy has increased, particularly in the Corresponding author: Ulla Heinonen Water Resources Laboratory Helsinki University of Technology - TKK P.O. Box 5200, FIN-02015 TKK, Finland Email: [email protected] countries where income is not equally distributed, and has become an integrated part of the economy in many countries (Becker, 2004). Thus, the informal economy - the refined definition of the International Labour Organisation (ILO) - could no longer be seen as a temporary phenomenon, or as a phenomenon that straightforwardly decreases with economic growth. In the recent decades the sector has grown around the world and it is currently the largest “economy” in many countries (ILO, 2002). It seems to be that if economic growth is not accompanied by improvements in employment and income distribution, the informal economy does not shrink. Instead, it seems to expand, both in urban and in

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Page 1: THE HIDDEN ROLE OF INFORMAL ECONOMY

Ulla Heinonen

Corresponding author:Ulla HeinonenWater Resources LaboratoryHelsinki University of Technology - TKKP.O. Box 5200, FIN-02015 TKK, FinlandEmail: [email protected]

Water Resources Laboratory, Helsinki University of Technology, Finland

THE HIDDEN ROLE OF INFORMAL ECONOMY:IS INFORMAL ECONOMY INSIGNIFICANT FOR

PHNOM PENH’S DEVELOPMENT?

Informal economy is often stated as a temporary phenomenon which diminishes along economic growth.

The sector is regularly taken as granted and its role for development is not properly seen. Around 80 percent

of the GDP in Cambodia is produced by the informal sector. Informal economy is also important for the

country’s urban areas and particularly for the country’s capital city. The economic development of Phnom

Penh, the capital, is combined with a growth in its non-agricultural informal sector. At the same time the

city’s slum settlements are mushrooming, creating more pressures on the informal sector. As a result, many

of the city’s informal workers have become working poors. Without proper protection and legalization

of the informal sector, these poor citizens cannot be lifted up from the poverty trap and the sustainable

development of the city cannot be achieved.

In the 1970s informal sector became a common topic in international development discussions. Informality was identifi ed as a continued existence of traditional activities and production methods that would disappear along with industrialization and modernization (Straub, 2005). The sector was seen marginal for growth and separate from the formal sector. However, later on the informal economy has increased, particularly in the

countries where income is not equally distributed, and has become an integrated part of the economy in many countries (Becker, 2004). Thus, the informal economy - the refi ned defi nition of the International Labour Organisation (ILO) - could no longer be seen as a temporary phenomenon, or as a phenomenon that straightforwardly decreases with economic growth.

In the recent decades the sector has grown around the world and it is currently the largest “economy” in many countries (ILO, 2002). It seems to be that if economic growth is not accompanied by improvements in employment and income distribution, the informal economy does not shrink. Instead, it seems to expand, both in urban and in

1 Introduction to informal economy

© 2008 TKK & Heinonen ISBN 978-951-22-9102-1Kummu, M., Keskinen, M. & Varis, O. (eds.): Modern Myths of the Mekong, pp. 123-132

Water & Development Publications - Helsinki University of Technology AB

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2 Economy, employment, and informality in Cambodia

2.1 Defi nition of the informal economy in Cambodia

The lack of consistent empirical measurements is evident in Cambodia, where the impact and volume of the informal economy has not been properly analyzed and its role in the country’s economy is poorly recognized. In Cambodia, the informal economy is defi ned as actions without offi cial or solid legal status, regulation or protection by state institutions, or as actions that are identifi ed with some of the following characteristics (Amin, 2002; Becker, 2004):

1. No fi rm or postal address2. Employees are self-employed

or road-side vendors3. No data through census survey are available

or the activities are not recognised4. Labour-intensive nature of

operations and quick turnover5. Use of energy input from

human or animal sources6. Non-structured premises without

regulations, licences, insurance, or taxes

rural areas. Besides, there exist evident linkages between the informal and formal economies. The informal sector provides services for formal actors, offers a fl exible labour market to absorb the surplus labour and has a signifi cant income and job generation potential (Becker, 2004). The studies of the World Bank (2004) showed that the majority of informal services are sold to individual customers, commonly to poor and middle-income urban dwellers (Bhowmik, 2005). The informal sector supplies products and services, which are not provided by the formal sector, or are otherwise unreachable for the poor citizens (Ishengoma & Kappel 2006).

The informal economy is very heterogeneous in terms of actors, activities, and scales (Sethuraman, 1997). The sector varies between countries, economies, and cultures (Thomas, 1995). In some countries the term ‘informal economy’ refers to the private sector, in some to grey economy (Trebilcock, 2005). It is a controversial topic and as a result there exist disagreements about its defi nition, estimation procedures, and their use in economic analysis (Schneider, 2002). The current defi nition of the informal economy includes a large amount of heterogeneity instead of conceptualising the term narrowly (Ishengoma & Kappel, 2006).

Schneider (2002) defi nes informal activities as unregistered economic activities that contribute to the offi cially calculated (or observed) Gross National Product. Thomas (1995) and Trebilcock (2005), on the other hand, characterise the informal economy as economic activities that, for various reasons, are not fully reported in the National Income Accounts or are insuffi ciently covered by formal arrangements. In other words, the informal economy contributes to the country’s economy but the activities are informal in terms of registration, tax payments, operating licences, conditions of employment, or regulations (Becker, 2004).

A modest progress in measuring the informal economy is achieved and presently there exist numerous ways of measurement: working hours,

share of the labour force, percent of GDP, consumption of electricity and currency demand (Schneider, 2002). Theoretical understanding of the causes and consequences is, nevertheless, still lagging in many parts of the world (Straub, 2005).

Informal activities take place in many forms. The work varies from part-time jobs after working hours, to work of immigrants who are not allowed to work in the formal sector (Schneider, 2002). In general, informal activities can be categorised into two sections: self-employed and non-permanent labour. In all developing countries the self-employed labour comprises a greater share of informal employment. This sector includes persons working as street vendors, taxi drivers, or in home-based enterprises. In Asia self-employment covers around 60 percent of the total informal sector (Becker, 2004).

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10001500200025003000350040004500

Garment Tourism Agriculture Others

Million US$/Thousands

GDP and Labour Force by Subsectors ( 2001)

Total GDP by Subsectors

Labour Force

InformalFormal

125

2.2 Employment and informalityA recent civil war, defi cient infrastructure, political instability, and extensive corruption have hindered the Cambodian economic development (World Bank, 2003; 2004). In 2004 around 35 percent of the 14 million Cambodians lived under the poverty line (~1,800 riels/person/day) (World Bank, 2006). Lately the country’s economy has, however, shown signs of recovery, and the economic growth has been around 6 percent. Nevertheless, the growth has not been stable and inequality remains high.

Agriculture is a very important sector in Cambodia covering 40 percent of the country’s GDP and employing 70 percent of the population. Service and industrial sectors are less important. Service sector employees around 20 percent and industrial sector 10 percent of the population (Ministry of Planning, 2001). As a poor agrarian country, Cambodia is very vulnerable to changes in natural resources. Drought and fl oods in the recent years, for example, have seriously affected the country’s economy. Diminishing agricultural activities and unemployment in rural areas have pushed people out of their villages in search of employment in towns and cities (Heinonen, 2006). Rural migrants do not often have the necessary skills or education to allow them to fi nd better paid, secure employment in the formal sector and hence they often end up working informally (Bhowmik, 2005).

The informal economy provides around 90 percent of all employment in Cambodia (Monyrath, 2005). The sector employs the majority of the 200,000 to 250,000 new workers entering the job market each year, while the country’s formal sector absorbs only 15,000 new labourers annually (USG, 2003; World Bank, 2004). Agriculture and agro-industry cover majority of the employment in the informal sector (Figure 1). However, the non-agricultural informal sector is twice the size of the formal in terms of GDP and labour force. It is also a largest employer in the urban areas. The informal sector provides around 60 to 80 percent of the Gross Domestic Product of the country (Monyrath, 2005; USG, 2003). Non-agricultural informal activities mostly in urban areas cover the greatest share, around 1,653 million dollars (Figure 1).

The garment and tourism industries and public administration dominate the small formal sector (Monyrath, 2005; Bajpai, 2004). Formal jobs provided by the government are few and they are not well paid (Bhowmik, 2005). Majority of the formal employment in Cambodia is very poorly paid, which pushes people to do extra work in the informal sector. Most of the part-time moto-taxi drivers in Phnom Penh, for instance, are government employees (USG, 2003). The formal private sector in Cambodia is also relatively small and limited, facing innumerable transaction costs

Figure 1 The GDP from the informal sector is four times higher than from the formal sector (USG, 2003).

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and barriers to operate (USG, 2003). To start a business in Cambodia is very time-consuming and costly, compared to the neighbouring countries. The taxes and bribes are lower in the informal sector and this is often the main reason why people do not register their activities (World Bank, 2004; Straub, 2005; Ishengoma & Kappel, 2006).

3 Informal economy in Phnom Penh There are three dominant sectors offering formal employment in Phnom Penh: public administration, garment industry and tourism (Monyrath, 2005). It is evident that these sectors are not able to offer employment for all of the city’s new dwellers that the city is gaining by its 4 percent annual growth. In addition, in many cases the formal sector is unable to provide enough income for its employees. Based on this mismatch majority of the Phnom Penh’s citizens work informally, at least on a part-time basis (Agnello & Moller, 2003).

Even though Cambodian formal sectors are primarily located in the towns and cities, particularly in Phnom Penh, informality runs the city’s economy. The informal economic activities – micro- and small enterprises, market sellers, non-permanent labour workers, moto-taxi drivers, and domestic helpers - have a major role in the economic performance of the capital city.

The informal economy tends also to absorb most of the growing labour force related to rural-urban migration when the manufacturing industry and off-farm activities do not grow with the same rapidity. The sector also answers the needs of the seasonal migrants coming to the city to earn supplementary income particularly in the dry season. And it also attracts rural migrants to Phnom Penh to provide low-cost goods and services for those employed in the formal and informal economies (Becker, 2004). The growth in the city’s garment industry couple of years ago, for instance, led to an increase in informal activities such as transportation, food, beverages, and accommodation to serve the people working in the formal sector. This also encouraged rural dwellers to migrate to the city (Monyrath, 2005).

3.1 Informality and povertyUrban poverty and informal employment are closely connected. Poor people in developing countries are often forced to work in the informal economy because of lack of capital and skills, gender, or ethnicity, which make them insignifi cant for the main labour force (Etherington & Simon, 1996). The studies of the International Labour Organisation show that informal status often means a greater likelihood of income variability, decline, and insecurity (Trebilcock, 2005). Informal economy attracts workforce from diverse backgrounds and, as a consequence, the labour force is very heterogeneous. Initial capital, gender, domicile, education, and contacts all infl uence the capabilities of informal employees to survive in their jobs. Often the rural migrants tend to fall into the lowest category of the informal economy (Trebilcock, 2005).

This is also common in Phnom Penh, where rural migrants and poor people dominate the labour force of the informal economy. The surveys of Etherington& Simon (1996) showed that in Phnom Penh the rural migrants often end up working as cyclo-drivers or temporary labourers. For example, over 70 percent of waste pickers in the city are poor rural migrants (Amin, 2002), whereas poor urban dwellers more often work as service sector workers or street vendors. This kind of division indicates that the rural migrants have low social status in the city and thus they have problems in exploiting of the informal credit systems.

The informal economy is the most important employer for the poor inhabitants of Phnom Penh. At present, 80 percent of the city’s 400,000 slum dwellers are employed in the informal economy (SUPF, 2003; URC, 2004). In addition, many children are involved in informal activities, working as shoe cleaners, rag pickers, sellers or beggars. The customary informal works in Phnom Penh are: mototaxi- and cyclo-drivers, food, gasoline and vegetable sellers, construction workers, electricity and water sellers, motorcycle repairers, rubbish collectors, brick workers and house servants (USG, 2003). There is an evident linkage between the work types in the informal

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sector, and the work types of the slum dwellers. Hence, relation between poverty and the informal economy, as a result of poor working conditions, and low income levels, is obvious (Sethuraman, 1997; Ishengoma & Kappel, 2006).

Figure 2 presents the obstacles that a poor private sector worker faces when trying to reach Phnom Penh’s formal sector. Most of the poor workers live in slums. They do not have secure tenure, proper housing or public services. They need informal products and services because they cannot reach the formal ones. As rural migrants, the workers often have a low social capital and do not have an interest in other activities than earning income (particularly seasonal migrants). These people mostly work in the informal sector because the formal jobs are limited and they do not have skills for these jobs. In addition, they do not have initial capital to start a proper business, the access to formal credit services is limited, and they do not have know-how about the registration activities and the forms that the formal sector could support them.

Informal activities are often targets of extortion and harassment by the public authorities. The work of

Figure 2 The informal worker faces many obstacles. Broken lines illustrate the barriers along the way.

the informal workers is disturbed by fi nes, different payments (e.g. hygiene), and violations, and due to all this emotional stress (Figure 2). Phnom Penh’s informal activities are not regulated. However, there are many regulations in the places where informal workers operate, and not following these guidelines (e.g. selling restrictions) leads to fi ning (USG, 2003). Bribes for the public authorities are also common, particularly for street vendors and micro-enterprises. All these stresses have an impact on the workers ability to survive in the city. As most of the informal workers are rarely organised, this hinders their ability to negotiate with the public authorities (Monyrath, 2005).

The regulation jungle drives the informal activities out from the authorized structures and, as a result, people work in the informal sector. The studies of the Urban Sector Group (USG, 2003) among Phnom Penh’s informal workers revealed that there are: a lack of information about registration methods, regulations and costs; not enough benefi ts compared to the amount of money that is needed for registration; wide opinion that small companies cannot be registered; and lack of information about where, when and how to register.

Formal Sector

Formal Services

Informal Employment

Informal Sector Worker

Informal SectorWorker

Informal Services

Formal Employment

Regulations Fines

Payments

Violations

Emotional

Stress

Lack of:

Skills

Capital

Credit

Know-how

Lack of:

Secure Tenure

Proper Housing

Social Capital

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Education of the Informal Sector Workersin Phnom Penh

128

4 Discussion – How to legalise informal sector?

The municipality of Phnom Penh seeks for poverty reduction and aims for economic development. When aiming to urban poverty reduction the problems of the city’s poor informal workers are those to be addressed (Monyrath, 2005). Every day around 300 000 slum dwellers work in Phnom Penh’s informal sector (SUPF, 2003). In addition, the slums absorbs majority of the city’s increasing population. Addressing this group would thus have an infl uence on almost half of the city’s informal workers.

The poor informal workers face many barriers in their daily existence and they carry a high risk of becoming working poor with earnings insuffi cient to raise themselves and their families above the

3.2 Other side of the coinThere is also another side in the Phnom Penh’s informal economy. And therefore it is too one-dimensional to associate informality directly with poverty. The studies of Chantly (1999) showed that the informal economy also provides employment for educated workers with entrepreneurial potential and skills (Figure 3). This indicates that the formal economy is unable to provide adequate employment for educated persons and thus they choose the opportunities that the informal sector has to offer (Amin, 2002).

The fi gure below is a clear evidence of inadequate governance and regulations, and the fact that the Phnom Penh’s formal sector is unable to provide enough income for its workers. One of the country’s challenges is thus to create productive jobs in the formal economy. Otherwise there is little hope for city’s sustainable economic growth. Phnom Penh cannot afford to lose the capabilities of educated citizens with potential skills (Chantly, 1999).

Phnom Penh’s informal sector also offers a playground for private companies that do not want to register because of the costs. The city’s informal private water services, for example, offer employment for thousands of informal workers. The private vendors buy water from city water offi cials or obtain water from ground or surface

Figure 3 The informal economy of Phnom Penh also attracts educated people (Chantly, 1999; Amin, 2002).

water sources and resell it to poor and middle-income inhabitants (USG, 2003). The survey of the Urban Sector Group (2003) reveals that an informal water seller earns roughly 346,000 riels monthly (87 US$), which is twice the salary that the government can offer. However, these activities are not regulated, which creates great challenges in terms of providing safe water supply particularly for the Phnom Penh’s poor citizens (Heinonen, 2008).

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poverty line (ILO, 2004). Even though the work in the informal sector is the way to earn some food on the table, the jobs are poorly paid, have poor working conditions, no social protection and excludes workers form social dialogue and decision-making, trapping its workers deeper into poverty (Ishengoma & Kappel, 2006).

To push informal workers from this trap, however, is easier said than done. Already, in the Urban Poverty Reduction Strategy of Phnom Penh in 1999, many good ways to improve the situation of urban poor were stated (Municipality of Phnom Penh, 1999). Nevertheless, the results have been weak. The city’s poor informal workers have worked very hard, often in unhealthy conditions and facing many obstacles. Still they remain poor either poorer than before. These workforces have made signifi cant contributions to the city’s development. The sector has kept down the urbanisation cost of the city by promoting fl exible labour market, absorbing extra labour from the formal sector and promoted the city by services such as water, energy and solid waste collection (Amin, 2002; Monyrath, 2005). But still, the signifi cance of the sector is not adequately recognized by the municipality.

To be able to guide the poor informal workers for better achievements and have a real impact in their level of livelihood, there is a great need for appropriate regulations, laws and policies. Regulating the activities of the informal sector, however, is an immense challenge. There is no one policy intervention that could address such a diverse entity. Additionally very often the increasing fi scal and regulatory burden leads to the enlargement of the informal sector or puts more troubles on informal workers activities (Palmade, 2002). To be able to legalize and regulate the sector, more information and dialogue with the informal sector is needed. The regulations need to be sensitive so as to be able to increase the productivity, quality, and working conditions of the informal sector (Becker, 2004). Only by understanding the needs and identifying the obstacles, that the informal sector is facing, proper and sustainable regulations can be established. Just putting extra pressure on the informal sector turns development

in an unwanted direction (Palmade, 2002). The regulations cannot be the same for poor informal workers and the informal companies that just want to avoid the extra burdens of registration.

The fi rst requirement in integrating Phnom Penh’s informal sector into the formal is providing land (Amin, 2002). Land and housing are not only the place to accommodate, they are often also the places to generate income. Hence, including poor people in the urban planning both in terms of their housing as well as of their income generation is vital for legalizing and regulating informal activities. The city’s slum settlements as well as the informal workers have been excluded from Phnom Penh’s development strategies and there have not been clear processes of city zoning and land use planning, which would also address the needs of the urban poor. In addition, the city does not have land-banking system for development purposes and when the demand for land is high due to the growing population and increasing investments, the poor have had a little room in the development discussions (Sophy, 2002). The study on Land Availability for City Development (2002) identifi ed, that there is a great need for reserving and allocating land for poor as well as set up a land development bank for reserving land for future community projects and investments.

The living conditions of the poor do not improve without decent work and income (Amin, 2002). This is also a reason why many slum upgrading processes have not led to long-term development. As a consequence, the upgrading processes of poor settlements that are taking place in the Phnom Penh needs to include also other aspects than just upgrading the housing and services (Heinonen, 2008).The city-wide and bottom-up participation approach of Asian Coalition for Housing Rights, for instance, could be one effi cient approach to also address the Phnom Penh’s informal workers (Heinonen, 2008).

To make the development sustainable in the long run, education, training schemes and support to workers’ organisations are essential for the capacity building of the informal workers. Via workers’

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organisations the informal sectors’ workers will get information about the regulations as well as the ways of registration. To avoid extra burdens, the means of registration need to be clear, transparent and simple. Micro-credits and saving groups are also essential part of the improvement process, which also builds believe and strength among the poor citizens.

The Municipality of Phnom Penh stated in the Poverty Reduction Strategy (1999) that they do not have enough fi nancial opportunities to support the urban poor. Supporting saving groups or micro-credit schemes do not, however, need enormous funds because already the small seed money can have a great impact. In addition, the possibilities of the formal private sector need to be search for.

5 Conclusions The informal economy acts as a crucial part of the economy in Phnom Penh and it is extremely important for the city and its development, providing employment, income, and services for the majority of the citizens. Around 80 percent of the city’s 400,000 slum dwellers earn their income from informal sources. The informal economy has also attracted educated people when the formal sector has been unable to offer proper employment and income. This has distorted the balance between the informal and formal economies and thus informality cannot be straightforwardly associated with poverty.

When trying to identify, legalize and regulate the city’s informal economy, there are two sides to address. On the other side there is the educated pool of workers that are working in the

informal sector since the formal sector (e.g public administration) is unable to pay enough income. And, then those who feel that registration of the company mean just extra burdens and cost, and gives only little in return. Another side of the coin is the city’s poor informal workers mostly living in slum settlements. These people do not have skills, capacities or capital to register their activities. And, as a matter of fact these people are disturbed by the formal arrangements such as regulations, fi nes and emotional stress that hinder their activities and possibilities to earn decent income.

The informal economy is not regulated, which has created many obstacles for the city’s development. To achieve sustainable development of the city’s economy and services, the municipality needs to co-operate with the informal sector, develop services to support, monitor and regulate informal activities, and lighten the registration process. To be able to create an effective legal framework for informal activities, more information about the sector and its needs, obstacles, and behaviours is needed.

The informal sector of the city has a lot of potential capabilities, good ideas, entrepreneurial skills, and education, which need to be exploited for Phnom Penh’s development.

This study is funded by the Academy of Finland (project 211010) and the Helsinki University of Technology. I would like to thank Prof. Pertti Vakkilainen and Dr. Olli Varis for their good comments and fruitful discussions.

Acknowledgements

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World Bank, 2006. Cambodia: Halving Poverty by 2015? World Bank, Phnom Penh.

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Modern Myths of the Mekong - Part III: Development