This chapter provides an overview of informality in the MENA region, in the context of recent economic trends and challenges. It presents key stylised facts on the informal economy, and relevant policy areas that affect formalisation, such as business and labour regulation, fiscal policies, and social protection systems. The chapter also discusses existing obstacles in the region for formalising employment and businesses.
Informality and Structural Transformation in Egypt, Iraq and Jordan
A Framework for Assessing Policy Responses in the MENA Region
2. Overview of informality in the MENA region
Abstract
Key messages
MENA economies’ increased vulnerability to current global economic shocks is rooted in enduring structural issues within the region. These challenges encompass modest yet volatile growth rates, stagnating productivity, a sluggish pace of economic transformation, low employment levels, particularly among youth and women, poor job quality, labour market disparities, fragmented social protection systems, insufficient foreign direct investment inflows, and a fragile investment climate. This context is both a suitable environment for the informal economy to flourish, as well as a partial reflex of its impact.
Informality in the region ranged between 20-30% of the GDP during the 1990-2018 period, although with shares varying significantly across countries. Depending on the model used to estimate the size of the informal economy in the MENA region, the informal economy has increased, decreased or remained constant, signalling the complexity of measuring this phenomenon and calling for more accurate data to enable appropriate policies to address it.
As countries step-up efforts to promote business and labour formalisation, it is important to comprehend the drivers of informality and stimuli for formalisation in the region, which include business regulation; taxation; labour market regulations; institutional quality and governance; social protection systems; social and cultural factors.
2.1. Economic trends and challenges in the MENA region
A new phase in the global economy has emerged since the onset of the COVID-19 pandemic. The series of shocks that followed – from Russia’s war of aggression against Ukraine to a sharp slowdown of economic activity in three major world economies (USA, China, and the Euro area) – have accompanied the global economy’s transition towards an era of higher inflation, rising interest rates and reduced investments (World Bank, 2022[1]; IMF, 2022[2]; OECD, 2022[3]). This new economic outlook has put particular stress on MENA economies where high interest rates have increased the debt service burden for several countries, further intensifying domestic debt crises; while high food, oil and natural gas prices have led to high domestic inflation, with the effect of exacerbating inequality and poverty in countries outside the Gulf Cooperation Council (GCC).
This greater exposure of MENA economies to current shocks has deep roots in long-standing structural challenges in the region, namely: modest albeit volatile growth rates, stagnating productivity, a slow pace of economic transformation, low employment – especially among youth and women-, poor jobs quality, labour market dualities, fragmented social protection systems, insufficient foreign direct investment inflows and a weak investment climate.
2.1.1. Economic growth
In the MENA region, the decade prior to the COVID-19 outbreak was characterised by relatively low growth. Economic growth in the MENA region also declined over the decade, from average GDP growth of 5.0% in 2010 to 1.2% in 2019 (Figure 2.1).
Figure 2.1. GDP growth, regions of the world
Annual, %
Note: Annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2015 prices, expressed in USD. The MENA region aggregate reflects the World Bank’s definition.
Source: World Bank, accessed on 10 July 2023.
In 2020, the COVID-19 outbreak triggered a major economic crisis affecting the whole world, including the MENA region where growth contracted by 3.8% on average. In 2021, the global economy began to rebound as countries lifted restrictions on economic activities, and sectors which had been acutely affected, e.g. services, started to recover. Average GDP growth in the MENA region rebounded to 4.5% in 2021, representing the highest growth rate of the region since 2010, driven also by a strong rebound in the oil sector in GCC, and soaring oil prices. By global comparison, however, the size of the MENA’s 2021 economic rebound was one of the lowest, better only in comparison with the Sub-Saharan African region. However, the MENA region’s economies continued to grow also in 2022, reaching 5.8%, unlike most of the rest of the world. However, MENA’s growth is projected to diminish in 2023 and 2024 due to both structural challenges inherent to the MENA region and spillovers from the global economic slowdown (World Bank, 2023[4]; IMF, 2023[5]).1
2.1.2. Slack labour markets
Economic growth in the MENA region has struggled to produce quality and high-productivity jobs on the labour markets already affected by a marked duality – with an overstretched public sector on the one hand and a high prevalence of informality and low productivity in the private sector on the other – and lack of dynamism (IMF, 2022[6]; Krafft et al., 2022[7]; World Bank, 2022[1]).
In the period 2011-22, labour productivity growth in MENA – measured in terms of real GDP per worker – was the lowest among regions of emerging markets and developing economies, with an average value of 1.6% (World Bank, 2023[4]). World Bank forecasts expect that labour productivity growth in the MENA region will remain weak, averaging 1.2% for the period 2023-25.2
Limited job creation and high unemployment remain a significant challenge in the region. The region continues to register the highest unemployment rate by global comparison, followed by Latin America and the Caribbean (Table 2.1). Compared to the pre-COVID-19 pandemic, the unemployment rate rose from 10.0% in 2019 to 10.7% in 2021, despite the fact that MENA economies had started to show signs of recovery.
The high unemployment rate is attributed mainly to countries outside the GCC, with official rates ranging from 7.4% in Egypt to 28.0% in Djibouti in 2021 – contrary to GCC countries where the small national population is employed in the public sector while most jobs in the private sector are filled by foreign workers. Although to a different degree across the region, women and youth are the groups most affected by unemployment prospects (IMF, 2022[6]). Women and youth in the MENA region continue to represent an untapped source of growth and productivity.
Table 2.1. Unemployment rates, selected MENA economies, 2019-21
% of total labour force
Notes: The ILO data for MENA include Iran and exclude Sudan. ILOEST database estimates unemployment rates, including imputing missing observations and projections, using a series of models that establish statistical relationships between observed labour market indicators and explanatory variables. Therefore, data is frequently updated.
Source: ILO modelled estimates (ILOEST), November 2022 (%), version updated on 23 February 2023 extracted on 10 July 2023.
2.1.3. Large informal economy
In the MENA region, informality is pervasive, representing an estimated 64.9% of total employment in 20223 and a GDP share of 20% or more (Elgin et al., 2021[8]). Recent analysis has observed limited progress in reducing informality in MENA economies over the past two decades (World Bank (2023[9]), Informality and Inclusive Growth in the Middle East and North Africa, and International Monetary Fund (2022[6]), Informality, Development, and the Business Cycle in North Africa). The significant size of the informal economy in MENA economies has inevitably affected their resilience to the recent economic shocks, highlighting the risks of increased vulnerability associated to informality (Box 2.1).
A labour market characterised by low productivity and high unemployment is both a result and a driver of the informal economy. Elgin et al. (2021[8]) estimated that informal output in the MENA region ranged between 20-25% of the official GDP in the period 1990-2018. Different models, however, point to different trends and patterns between countries. Using the dynamic general equilibrium model (DGE), Elgin et. al. (2021[8]) found that since 1990 the size of the informal economy had slightly reduced in the MENA region as a whole. In 2018, only in Egypt, Morocco, and Tunisia did the informal economy account for more than 30% of their official GDP. On the other hand, the multiple-indicators, multiple-causes model (MIMIC) indicates that the share of informal economy in the official GDP remained stable in the period 1990-2018, with several countries (Algeria, Egypt, Lebanon, Libya, Morocco, Tunisia) having an informal output representing more than 30% of their GDP.
Figure 2.2. Estimates of informal output, selected Arab countries
% of official GDP, average by decade
Note: Dynamic general equilibrium model based (DGE). Post 2018 data currently not available.
Source: Authors based on data from Elgin et. al. (2021[8]).
The significant size of the informal economy in MENA economies has inevitably affected their resilience to the recent economic shocks, highlighting the risks of increased vulnerability associated to informality.
Box 2.1. Informality, vulnerability, development, and growth
Informality and vulnerability
Informality represents a source of vulnerability because it is assumed to carry a series of negative implications for both individuals and firms, as well as the society at large.
At an individual level, informal workers struggle to access fundamental labour rights and protections, social security, and minimum wages (ILO, 2015[10]; ILO, 2021[11]), making them particularly vulnerable to economic shocks (IMF, 2022[6]). Although informal employment may provide a short-term alternative to unemployment and provide income-earning opportunities, in the long-term it is typically understood to be a barrier to career development and social mobility for many informal workers, as lack of training and poor working conditions generally characterise the informal sector (Saoudi, 2022[12]; IMF, 2022[6]).
Informality also affects the business environment by creating unfair competition between informal firms and those that comply with legal and regulatory framework. In this manner, informality risks provoking ‘hyper-casualisation’, i.e. pushing formal enterprises into the informal economy to compete (Williams, 2014[13]). Informal firms also tend to be less productive (Medina and Schneider, 2019[14]), and with lower investment and expansion prospects as they face greater difficulties in accessing credit, public infrastructure, and markets (Nielsen and White, 2021[15]; World Bank, 2022[1]; OECD/ILO, 2019[16]; La Porta and Shleifer, 2014[17]).
For the society, informality brings a loss of government revenue to be invested for social cohesion and inclusive development. In a context of pervasive informality, governments risk losing their regulatory control of work conditions in the society, thus weakening the rule of law (ILO, 2019[18]; Williams, 2014[13]).
Informality, development and growth
Empirical evidence has suggested that as economic development progresses, informality shrinks (La Porta and Shleifer, 2014[17]; Loayza and Rigolini, 2006[19]). Recent research (Chacaltana Janampa, Bonnet and Garcia, 2022[20]), argued that both the economic structure and the pattern of growth matter for the size of the informal economy.
The impact of informality on economic growth is difficult to disentangle given that informality can both influence economic growth and be affected by it (e.g. see discussions in (Joshi, Prichard and Heady, 2014[21])). While the literature is inconclusive about the magnitude of the effect, it is argued that the causality is likely to be bidirectional (see overview in Annex 1.A). Indeed, the relationship between the size and nature of the informal economy and growth is complex and dynamic. This relationship depends on a variety of factors, and economic growth is a necessary but not sufficient condition to address informality. Using meta-analysis, (Afonso, Neves and Pinto, 2020[22]) found that the average effect of the non-observed economy on economic growth is statistically insignificant. On the contrary, (Nikopour, Habibullah and Schneider, 2008[23]) found that the relationship between informality and growth follows an “S”-shaped cubic function: i) in the early stages of development, the relationship is positive; ii) in the later stages of development, it is negative; and iii) at a certain level of income, there is a new inflection point, and a new upward phase starts. Elgin and Birinci (2016[24]) found an inverted-U relationship between informal economy size and growth of GDP per capita: small and large sizes of the informal economy are associated with low growth while medium sizes with higher levels of growth.
2.1.4. Fragmented social protection systems and limited coverage
The vulnerabilities of the region to recent shocks have put at risk the progress made in reducing inequality and poverty, with potential long-term adverse effects. In fact, in addition to jobs losses due to the COVID-19 crisis, the current inflation crisis has generated a substantial fall in real monthly wages especially among low-income groups (ILO, 2022[25]) and more generally a fall in labour income. Also, it will be important to analyse whether those shocks led to more informal sector and employment, considering that the size of those was already high before the shocks. (Lopez Acevedo et al., 2022[26]) estimated that the rises in food and energy prices since the beginning of Russia’s war of aggression against Ukraine could push an additional 23 million people living in the MENA region into poverty. Moreover, it is especially young people, women, migrants and low-skilled who face a high likelihood of impoverishment in the region (IMF, 2022[2]; OECD, 2022[27]).
In this context, a crucial role is played by social protection systems to transition workers and households out of poverty. However, these are still relatively underdeveloped in the MENA region, with less than half of the households in the poorest quintile receiving some type of social assistance prior to the COVID-19 pandemic (Ohnsorge and Yu, 2022[28]). The latest Arab Human Development Report (UNDP, 2022[29]) and a recent ESCWA/UNDP/UNICEF (2022[30]) report highlighted the gaps in social expenditures, as well as inadequacy of social protection coverage and benefits in Arab countries.
Indeed, the region has the second-lowest social protection coverage, globally, Arab League’s coverage rate is the second lowest globally, after sub-Saharan Africa (at 13.7%) (Figure 2.3). In 2020, in the midst of the COVID-19 crisis, only 35.1% of population in the region were covered by at least one social protection programme.
Figure 2.3. Proportion of population covered by social protection floors/systems in 2020 (%)
Note that the definition of the Arab League region, partly differs from the countries covered under MENA definition in this report since data on the Arab League also include Comoros and Mauritania.
Source: ILOSTAT, https://ilostat.ilo.org/topics/social-protection/ (accessed on 24 March 2023).
Low pension coverage (37.2% of persons above retirement age receiving of pension) and work injury coverage (46.2% of persons employed covered in the event of work injury), as well as very low coverage levels for unemployment insurance (7.0% of unemployed receiving unemployment benefits) also suggest that informality affects both older and younger generations in the MENA region. In 2020, less than half of the employed population in the countries of the Arab League was covered against work injury.
Further, the low coverage of unemployment risk reflects underdevelopment of unemployment insurance in many MENA economies. The provision of adequate unemployment insurance could instead make the social insurance system more attractive and hence increase workers’ incentives to transition to formality. The lack of social protection benefits that satisfy the population’s needs and expectations (e.g. in the uncertain labour market of the MENA region, unemployment insurance could be one of workers’ most immediate need), and the inadequacy of benefits offered within existing programmes, can contribute to the growth of the informal economy (e.g. Gajigo and Hallward-Driemeier (2012[31])).
2.2. Stylised facts about informality
2.2.1. Determinants of informality
There is a wealth of studies on the determinants of informality and the barriers to formalisation of enterprises and of jobs. These include business regulation; taxation; labour market regulations; institutional quality and governance; social protection systems; social and cultural factors.
Onerous business regulation, such as complex administrative procedures, paperwork and bureaucracy that consume time and resources tend to increase the costs, and reduce the benefits of operating formally, especially in countries with poor public service delivery (OECD/ILO, 2019[16]). When entry costs are high and perceived benefits are meagre, firms will have a propensity to operate informally.
Fiscal regulation can influence formalisation.
The complexity of the tax code can imply high costs for small firms that may need to contract professional assistance to file appropriate tax declarations (Everest-Phillips, 2008[32]; Joshi, Prichard and Heady, 2014[21]; Nielsen and White, 2021[15]). This aspect highlights the role of fiscal (il)literacy.
Individuals operating small informal, low-skill demanding businesses generally tend to have a lower level of education (Davidescu et al., 2022[33]; Fernández and Villar, 2017[34]) and, in turn, lower levels of fiscal literacy and understanding of tax liabilities, and proper maintenance of records and bookkeeping to substantiate tax declarations (Araujo-Bonjean and Chambas, 2003[35])
Self-employed professional classes, on the contrary, may decide to operate on a cash basis to limit their tax liabilities.
If tax enforcement is de facto arbitrary, and adherence to tax obligations is not effectively and universally enforced, the perceived risk of penalisation is low, which disincentivises compliance with fiscal regulations.
(The perception of) high tax burdens may lower the ‘tax morale’ and encourage workers and firms to avoid taxes and operate in informal economy (Williams and Schneider, 2016[36]).
Recent research from Ghana suggests that many informal actors pay a range of taxes, permits, levies and fees, and that overall, the ratio of taxes to earnings is substantially higher than for formal workers, suggesting that for substantial proportions of the informal sector there is little room for further taxation or contributions (Anyidoho et al., 2022[37]). IMF (2022[6]) argues that a large wedge between pre-tax total labour costs and after-tax labour earnings strongly incentivises informality (or at least, contracting informal labour).
In MENA economies, Islam et al. (Islam, Moosa and Saliola, 2022[38]) found that non-GCC countries impose relatively high tax rates, with nearly 25% of corporate profits spent on labour taxes and social security contributions, unlike GCC countries who have low taxes on corporate profit.
Labour market regulation represents the basis for the functioning and quality of the labour market. Excessive rigidity of labour market regulation can lead to an increase of informal employment by discouraging entrepreneurs from formalising their businesses and formally contracting employees (European Union/OECD, 2015[39]).
Countries in the MENA region feature somewhat rigid labour market regulations, requiring high severance pay in the case of layoffs, as well as other restrictive regulation in relation to the use of fixed-term contracts in several countries (Islam, Moosa and Saliola, 2022[38]).
In MENA, some groups of workers are especially excluded from the scope of social security and labour law (or at least of provisions): e.g. domestic workers, agricultural workers in some countries. And I would suggest make this clear distinction between
A virtual path toward decent jobs and formalisation would involve ensuring the extension of labour laws and regulations to all groups not yet covered; an adequate level of legal protection: e.g. level of benefits, modalities to comply, remove unfortunate thresholds; and the effective implementation of these labour laws and regulations.
The magnitude of the impact of business, fiscal and labour market regulations on the phenomenon of informality is determined by institutional quality and governance (Loayza, Oviedo and Servén, 2005[40]).
Good governance and institutions are critical to strong development outcomes. Numerous studies highlighted the impact they have on the size of informality in a country.
Several studies have shown that weak rule of law, inefficient judiciary systems, weak enforcement powers, corruption and the lack of transparency all increase the costs of formality and disincentivise investments in the formal economy (Gajigo and Hallward-Driemeier, 2012[31]; Maiti and Bhattacharyya, 2020[41]; Buehn and Schneider, 2012[42]; Dreher, Kotsogiannis and McCorriston, 2009[43]).
IMF estimated that the gap in the quality of governance between North African countries and advanced economies explains almost half of the excess informality registered in North Africa (IMF, 2022[6]).
Public trust in government is one reflexion of institutional quality and governance in a country, with prolonged governance crisis leading to an erosion of public trust. According to the a recent Arab Barometer (Figure 2.4), trust in government varies greatly in the region: with lowest values reported in Lebanon where only 4% of surveyed population declared to have a great deal or quite a lot of trust in government, and with highest values reported in Morocco where the trust in government reached 53%.
Figure 2.4. Trust in government in selected MENA economies, 2020-21
Source: Arab Barometer Wave VI, July 2020 – April 2021.
The lack of trust in the government, driven also by corruption, makes businesses and workers more likely to operate informally as they tend to avoid interactions with public officials and related inspections (OECD, 2021[44]). To be noted, informality could also spur corruption, i.e. the flourishing of the informal economy can generate the rent for public officers to get corrupted.
Provided that services exist and are adequate (adequate social security benefits for instance) or that formality is associated to real /benefits, improving the quality of services provided by public institutions (e.g. through streamlining and digitalization of procedures that reduce also the risk of corruption) could have a positive impact on trust in government and support the formalization efforts (OECD, 2021[44]). ILO Recommendation 204 explicitly calls its member states to “take measures to promote anti-corruption efforts and good governance” as part of their efforts to promote transition to formal economy.
Other factors influencing decisions surrounding the formalisation of labour include the presence of fragmented and parallel social protection systems, e.g. social insurance, social assistance, informal social protection, community-led or other forms of collective, non-governmental provision of social assistance.4 Moreover, various government-provided schemes may generate an unequal bundle of services that are provided to citizens, which may lead to deficiencies in quality and inequities in the provision of services that discourages workers from enrolling in government social insurance programmes, i.e. labour formalisation. If social protection benefits are not adequate with respect to needs and expectations, while the contribution rates are high relative to market income, informality will remain high.
The role of social and cultural factors cannot be disregarded. Social and cultural factors for instance for instance plays an important role in the persistent informality of domestic workers. Social networks that are dense can be one important factor in promoting informality since, to circumvent national regulations, the informal sector needs a sense of collective social involvement (Aguilar and Campuzano, 2009[45]). This is driven by fear of formalisation and a feeling of security by staying within the fraternity of informal businesses.
Lastly, the level of development of financial markets can play a role because costly access to credit could push firms to remain informal. As the cost of credit lowers with financial market development, more firms may find optimal to transition to formality. There is large literature on this (see for instance Capasso, Ohnsorge and Yu, “Informality and financial development: A literature review”, The Manchester School, Vol. 90, September 2022).
2.2.2. Informal employment in the MENA region
Worldwide the practice of informal working arrangements is significantly spread, with the highest informal employment rate in 2022 registered in the Sub-Saharan Africa (87.3%) followed by the Asia and the Pacific (65.6%) and the MENA region (64.9%) (Figure 2.5).
The informal employment rate decreased over the last decade in all regions, except the MENA where it had registered a rise from 59.9% in 2012 up to 64.9% in 2022. Overall, the informal employment in the MENA region can be defined as both a pervasive and growing trend. Despite a small contraction in the informal employment rate in 2020 – driven also by the fact that the COVID-19 pandemic has disproportionately affected informal workers – informality expanded further in 2021. The MENA region’s post-pandemic employment recovery, which has started in 2021, has been mainly driven by informal jobs which rebounded much faster than formal jobs (ILO, 2023[46]). The reason lies in the fact that the employment recovery that followed the lifting of COVID-19 restrictions has not been coupled with better job opportunities, thus pushing workers into jobs of poorer quality including informal jobs.
Figure 2.5. Informal employment rate, regions of the world
Population of 15+
Note: The informality estimates include both nationally reported observations and imputed data for countries with missing data through five separate econometric models. Caution is needed in interpreting the estimates, especially for the MENA region where real data used as a basis for modelling is limited. See: https://www.ilo.org/ilostat-files/Documents/TEM.pdf
Source: ILOSTAT, ILO modelled estimates, November 2022 (%), accessed on 09 July 2023.
When analysing the phenomenon of informality, it should be considered that MENA economies do differ in their socio-economic conditions. This difference is visible, for instance, when looking at how GCC and non-GCC economies have absorbed recent shocks. The scarcity of data limits the possibility to fully grasp the heterogeneity of informal employment across the region. According to the latest available data, in non-GCC countries around 50% or more of those employed are informal workers.
The total informal employment rate, however, hides important gender differences in the MENA region, which become more prominent in times of shocks. Over the past decade, in several MENA economies men have been more likely to take up informal job in comparison with women.
Generally, in the MENA region informal employment among men rose over the past decade, whereas the informal employment of women registered a significant contraction in the period 201720, declining from 60% to 54%, but the trend was inverted in 2020 when lockdowns impeded informal-firm-dominated service sector (IMF, 2022[6]).
In the wake of the COVID-19 pandemic, women employed informally have suffered bigger job losses in comparison to men. In 2020 the informal employment of women declined by 2.3% in respect to 2019, while the rate of men increased in the same period.
The literature has argued that the burden of women’s unpaid care work together with informal workers’ limited access to job retention programmes and flexible working arrangements has led to larger job losses for informally employed women (ILO, 2023[46]). As a result, the 2019-20 decrease in informal employment among women did not translate in higher formal employment rates, but rather in an increase of female unemployment (Table 2.2) or in exiting the labour force all together. The trend of decrease in informal employment rates of women, however, has reversed since 2021, with more women taking informal jobs.
Data on the age distribution of informal workers in the MENA region also points to large inequalities on the region’s labour markets, with country-specific gender differences. Young workers (15-24 years of age) are especially vulnerable to informality in all the MENA economies for which data are available. According to ILO data, in Egypt and Iraq most young workers work under informal arrangements, but statistics available at the national level may differ from data presented in Table 2.2.
Table 2.2. Informal employment rate by age and sex, selected MENA economies
Note: Informal employment rate according to last available national LFS data.
*Data for Egypt for 2020 under revision by ILO.
Source: ILOSTAT, LFS database.
It is well documented that education tends to be negatively correlated with the likelihood of being employed informally (Davidescu et al., 2022[33]; Fernández and Villar, 2017[34]).
In all MENA economies, the informal employment is most prevalent among workers with basic or lower education attainment (Table 2.3). This is also reflected in the distribution of workers by occupation skills level where low skill jobs absorb most informal workers (Table 2.4).
However, MENA economies register also very high informality among workers with intermediate levels of education, as well as employ more than one third of workers with high education informally, except for Djibouti and Jordan.
These findings are not surprising given that there is a higher demand for informal workers in jobs with medium skills level: according to the latest available data, more than two thirds of jobs requiring medium skills level are carried out by informal workers. A not negligible demand for informal workers is also reported for jobs requiring a high level of skills. Indeed, with exception of Jordan, over between 20%-30% of high skill jobs in the countries presented in Table 2.4 are carried out by informal workers, reaching almost 70% on the Somalian labour market.
Table 2.3. Informal employment rate, by education level, selected MENA economies
Note: Informal employment rate according to last available national LFS data.
*Data for Egypt for 2020 under revision by ILO.
Source: ILOSTAT, LFS database.
Table 2.4. Informal employment rate by economic activity and occupation skill level, selected MENA economies
Note: Informal employment rate according to last available national LFS data. *Data for Egypt for 2020 under revision by ILO.
Source: ILOSTAT, LFS database.
2.2.3. Key challenges for businesses
Micro, small and medium-sized enterprises (MSMEs) represent the major source of employment and job creation in the MENA region (IMF, 2019[47]). According to the MSME Economic Indicators Analysis (IFC, 2019[48]), more than 10 million MSMEs operated formally in the MENA region in 2019, accounting for more than 90% of all formal businesses and with a density (enterprise per 1 000 people) heavily skewed towards micro enterprises. In the context of the informal sector, a distinction between two types of informal actors can be made: on one side, micro-enterprises operated by self-employed individuals or family members (including highly skilled professionals and low-skilled street vendors or domestic workers) and on the other side SMEs. While both micro-enterprises and SMEs face many common obstacles when it comes to formalization, some drivers have a different weight between the two informal actors, for example the choice of self-employed individuals to operate informally may be driven more by the lack of access to formal employment opportunities, whereas SMEs may adopt informal practices more as a response to competitive pressures.
The lack of data does not allow to accurately estimate the number of firms operating informally, as highlighted above. Nonetheless, insights can be obtained, for instance, by examining the magnitude of the unfair competition generated by informal businesses. According to the World Bank Enterprise Survey, around half of the formal businesses declared that they have competed against unregistered or informal firms, affecting both the manufacturing and the service sector almost equally (Table 2.5). A notable exception is Saudi Arabia, where less than 20% of formal businesses have faced such competition.
In the manufacturing sector in Tunisia, Jordan, and Lebanon, as well as and in the service sector in Tunisia, the share of formal businesses facing competition of informal firms rises to around 60%. In Sudan, almost all surveyed businesses, in both manufacturing and service sector, reported competing against informal firms.
In the service sector, retail and wholesale are the activities where formal firms face the highest competition from informal businesses, whose practices are identified as a major constraint in doing business.
In the manufacturing sector, it is the food manufacturing industry where the competition against unregistered or informal businesses is most widely reported; however, it is the practices of the garments industry and ‘other manufacturing’ that have been identified as the major constraint for doing business by formal firms.
Table 2.5. Competition between formal and informal businesses, selected MENA economies
Note: The World Bank Enterprise Survey covers only manufacturing and services sectors, corresponding to ISIC codes 10-33, 41-43, 45-47, 49-53, 55-56, 58, 61-62, 69-75, 79, and 95 (ISIC Rev.4).
Source: World Bank Enterprise Survey accessed on 10 July 2023.
Informal businesses are not only a source of unfair competition, but in some countries and industries their activities represent a major obstacle for the growth of the formal private sector. This can also create a risk of ‘a race to the bottom’ in which formal entrepreneurs, especially those working in low value-added activities, go informal in order to survive (European Union/OECD, 2015[39]). Promoting the transition of informal firms toward formality, as well as impeding the transition of formal firms toward informality, is an essential effort for the development of a vibrant private sector in MENA.
However, the complexity of the business formalisation process cannot be underestimated as the entrepreneur’s decision to formalise, and remain formal, is conditioned by numerous interrelated factors. As discussed, the challenges for formalisation pertain to numerous spheres such as business, fiscal and labour market regulations, institutional quality and governance, social protection systems and, more generally, to social and cultural factors.
Among others, cumbersome bureaucratic procedures required to register a business, together with all the necessary steps for businesses to pay taxes or comply with government regulations, such as licenses and/or permits to operate, pose immense barriers to formalisations.
In some cases, the initial licencing and business registration fees might be set at cost-prohibitive levels, penalising small businesses (OECD, 2007[49]). The payment of fees to formalise a business becomes a major barrier to formalisation, especially for informal businesses such as street vendors selling from carts or waste collectors. Business owners might feel that they are better off not being formalised due to the high financial obligations associated with formalisation (ILO, 2021[50]).
Administrative delays due to slow movement of paperwork at government offices, rent seeking attitude of officials, abuse of authority, and over-centralisation and corruption, all contribute to creating barriers to formalisation. In some developing countries, years of poor legal practices and enactment of laws have created a labyrinth of complexity and irregularity that has caused important regulatory barriers for businesses wanting to formalise (OECD/ILO, 2019[16]; OECD, 2007[49]).
It should be stressed that the lack of information, knowledge and awareness also plays a significant role in hindering the formalisation of businesses. Governments generally focus on formal businesses while formulating laws and regulations, disregarding the conditions informal businesses with the assumption that these enterprises will learn and comply with these rules and regulations (ILO, 2021[11]). Ultimately, the incentive to operate formally will depend on business owners’ perceived balance between overall costs and benefits. An entrepreneur’s decision to establish formally a business and remain formal, or to transition toward formality, represents the result of a complex analysis of numerous, interrelated factors and their respective incentives and disincentives.
Assessing the success of formalisation measures in MENA economies is complicated given the complexity of drivers as well as limited data availability. Some insights can be obtained from the World Bank Enterprise Survey which provides data on the firms, in eleven MENA economies, which have transitioned from informality to formality at one point of their business activities (Table 2.6).
In the manufacturing industry, Iraq and Yemen register the lowest share of businesses with formal registration at the time of their establishment (63.7% and 76.3% respectively), followed by Morocco and Egypt (85.3%, 86.7% and 88.4% respectively), while in the remaining countries the share of firms starting their business formally is above 90%. The average number of years during which a firm operated informally prior to its registration varies across the countries, with Iraq registering the longest period needed to transition to formality (equal to 1.6 years) and Saudi Arabia the shortest period (0.1 years).
In the service sector, Iraq and Yemen also have the lowest ranking as concerns businesses formally registered at the start of their operations (only two thirds of surveyed firms). On the contrary, in Djibouti, Jordan, and Sudan almost all surveyed firms in the service sector reported to have started their activities formally. In Iraq and Yemen, the service-sector firms needed, on average, more than one year to transition from informality to formality, whereas in other countries the firms carried out this transition, on average, in less than one year.
It should be stressed that these findings refer only to firms in the MENA region that have transitioned to formality at one point of their business activity. Significant knowledge and data gaps remain regarding: a) °firms that have started their business informally and are still operating without registration; b) firms that had started and ceased their business operations informally; and c) firms that have started their business formally but have transitioned to informality.
Table 2.6. Registration status at the start of operations and formalisation time
Note: The World Bank Enterprise Survey covers only manufacturing and services sectors, corresponding to ISIC codes 10-33, 41-43, 45-47, 49-53, 55-56, 58, 61-62, 69-75, 79, and 95 (ISIC Rev.4).
Source: World Bank Enterprise Survey (accessed on 10 July 2023).
Annex 2.A. The relationship between informality, development, and economic growth
Source: Authors’ elaboration based on literature review.
Annex 2.B. Additional figures
Annex Figure 2.B.1. Proportion of population covered by social protection schemes, 2020 or latest available
Percentage of total population
Source: ILOSTAT (accessed on 16 February 2023).
Annex Figure 2.B.2. Number of COVID 19 policy responses
Source: IPC-IG. 2021. Social Protection Responses to COVID-19 in the Global South: Tracking Matrix.
Annex Figure 2.B.3. Number of policy responses by type of support
Source: IPC-IG. 2021. Social Protection Responses to COVID-19 in the Global South: Tracking Matrix.
Annex Figure 2.B.4. COVID-19 policy responses classified by type of instrument
Source: IPC-IG. 2021. Social Protection Responses to COVID-19 in the Global South: Tracking Matrix.
Annex Figure 2.B.5. Identified social insurance COVID 19 response measures, by country
Source: IPC-IG. 2021. Social Protection Responses to COVID-19 in the Global South: Tracking Matrix.
Annex Figure 2.B.6. Number of COVID 19 policy response and targeted population, by country
Source: IPC-IG. 2021. Social Protection Responses to COVID-19 in the Global South: Tracking Matrix
Annex Figure 2.B.7. Multiple indicators multiple causes model-based (MIMIC) estimates of informal output (percentage of official GDP), Selected Arab countries, average by decade
Source: Authors’ illustration based on data from Elgin et. al. (2021[8]).
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Notes
← 1. According to the World Bank (2023[4]), the MENA region is projected to grow by 2.2% in 2023 and 3.3% in 2024. Contrary to data in Figure 2.1, World Bank estimates are based on GDP and expenditure components measured in average 2010-2019 prices and market exchange rates. The IMF (2023[5]) projects the growth of the MENA region to be equal to 2.9% in 2023 and 3.5% in 2024. Both World Bank and IMF forecasts for 2023-2024 are subject to updates.
← 2. The World Bank projections assume an unchanged employment to population ratio from 2021 levels.
← 3. Informal employment rate, ILO modelled estimates by sex.
← 4. See discussions in Van den Boogaard and Santoro, 2022; and Van den Boogaard et al., 2019 for research on informal taxation and community-driven provision of public goods. See also Amiri and Jackson, 2022 for an example of non-state actor taxation in Afghanistan.