Should competition agencies care about the informal sector?
Actually, yes. Informal firms can operate in the same product or geographic markets as formal firms and therefore affect the competition level. So what can competition agencies do to address the informal sector? The OECD recently held a forum on competition that gathered delegates from over 100 competition agencies. One of the sessions had the purpose of increasing the knowledge about the role of the informal sector for competition. First, can informality be good for competition? On one hand unregistered firms may be unfair competitors to the formally registered companies because informal firms can gain price advantage by not paying taxes and not complying with regulations. Here the competition agencies have very limited power, since the enforcement of these regulations is often outside their jurisdiction. Addressing these non-compliances are normally the job of tax authorities and other regulation agencies. On the other hand, informal firms can increase the degree of competition in a market by reducing the market share of formal firms. Competition agencies are in fact taking informal firms when computing market shares. The challenge in this case is to measure the market share of informal firms. Competition agencies are being creative about it. For instance, in Bulgaria the competition agency use the purchases of cement (i.e., the main input of the industry being analyzed) to assess the market share of informal firms in the ready-mix concrete market.
Second, are informal firms subject to uncompetitive practices? In some case yes. Informal firms tend to be small with limited market power. These firms often sell to formal ones that can be large players in the market having monopsony power. Since the sellers are not registered firms, the competition agencies have limited to defend them again the buyer with market power.
Competition agencies need to take into account the informal sector when assessing market concentration. However, the informal sector is only a second best solution for increasing competition. Ideally, competition should be increased through formal firms that tend to be more productive, provide better quality products to consumers and give better benefits to workers. Doing Business reforms by promoting formalization can also have a role in increasing fair competition.
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The informal sector contributes only marginally, if at all, to competition. If you visit any African market you will see scores of shops and stalls selling the exact same merchandise - plastic basins, aluminum cookware, flip-flops, batteries - at exactly the same prices, because each of them buys the merchandise from a very small number of importers and wholesalers whose own prices are almost identical.
The same thing holds true when you have a single large firm - or a very small number of big firms - in a sector, which sources certain inputs from smaller companies. The big firms are in a position to dictate prices, although this is a function of relative size and market concentration rather than of informality. You can see how companies like Wal-Mart and General Motors squeeze their suppliers and, in effect, dictate prices to them.
It would be dishonest for competition authorities to excuse monopolies or near-monopolies on the grounds that the hundreds of informal businesses provide some measure of real competition. These agencies should forget about the informal sector and concentrate on increasing competition in the formal sector, where it matters most.
Posted by: Chip Krakoff | Feb 28, 2009 11:20:13 AM
I think it is necessary to define "informal sector" in this context, isn't it?
If we regard those firms with few employees, low productivity, little value adding etc. to constitute the "informal sector" than indeed these are not the ones spurring competition and actually we'll find many firm like this in least developed countries. I think this understanding of the "informal sector" is underlying the previous comment - I hope I got you right here?
On the other hand, as I understand, the Doing Business project regards all firms - no matter what size, productivity etc. -, which are simply not (or just partly) registered to constitute the "informal sector". In this case there are certainly competitive firms, which are operating without a licence or are not declaring all their profits so that they indeed are sort of unfair competition to 100% formal firms. So approaches to completely formalize these sort of firms are justified and important.
But despite definitions of the "informal sector" at the end of the day what matters for competition is innovation not formality or informality. Firms need to come up with new products and services or find ways to produce existing ones cheaper than others. If they achieve the latter by being informal then this unfair competition doubtless often has negative effects (less benefits for workers, less quality for consumers). With regard to developing countries I would, however, question if this sort of unfair competition is taking place on a large scale. I would rather support the argument of the previous comment. From my point of in these countries informal firms are mostly not really innovative, therefore the sort of "healthy" competition which is driving progress regarding technology, processes etc. is not taking place.
So are firms "more productive, provide better quality products to consumers and give better benefits to workers" mainly because they are formal? I don't think so, therefore just formalising as many firms as possible, which should be comparatively easy from a technical point of view, is not right prescription if it comes without an idea how to stimulate innovation. For competition agencies in developing countries this would mean that they can try to ensure fair competition among the few competitive firms but probably have to wait for a broader development of competitive firms so that there is actually a critical mass of firms which will then make good regulation of competition and competition laws an important issue for economic development.
Posted by: Christian von Drachenfels | Mar 4, 2009 12:42:03 PM