- Overview
- Concept of Informal Sector
- Measuring the size of Informal Sector
- Self-Employment and Business Development
- Labor Market and Tax Regulations
- Coping Strategies and Exclusion
- Corruption and Governance
- Country Specific Information | | Corruption and Governance
Corruption has a direct impact on the size of the informal economy. It increases the cost of creating new businesses and staying in business within the formal economy - unofficial payments and unpredictability of their size and frequency drive the costs and risks so high that the entrepreneurs prefer to move their businesses underground to avoid bribes that they have to pay for services such as registration licensing, permits. Corruption in social services makes them less affordable and leads to creation of alternative services in the informal sector. Corruption at high levels of government such as capture of the state by vested interests has even a more profound impact on the degree of informality in the economies: it forms barriers to entry by creating a less competitive business environment and adds to business risks by increasing the level of unpredictability of government policies that are captured.
Weaknesses in governance – governance being defined as the way in which public institutions perform their functions in a country – are strongly correlated with deficiencies in development. Bad governance is associated with corruption, distortion of government budgets, inequitable growth, social exclusion, lack of trust in authorities. Inefficiency of formal governance institutions leads to creation of informal institutions that substitute for the functions that the formal ones are unable to perform.
Quality of Governance and the Size of the Informal Sector: Empirical Evidence
S.Johnson, D.Kaufmann, and A.Shleifer (The Unofficial Economy in Transition. Brookings Papers on Economic Activity, 1997) found that, in post-communist economies, the unofficial economy's share of GDP is determined by the extent of control rights held by bureaucrats and politicians. In many of the economies of Central and eastern Europe and the Former Soviet Union, the transition has been accompanied by the rise of unofficial sectors, in which firms avoid official taxes and regulations and whose output generally is not measured in official statistics. The authors examine how the interplay of politics and economic and institutional incentives influences the growth of the unofficial economy, and in turn how the unofficial economy affects economic performance. The outcome is described as a "bad equilibrium": the discretionary application of heavy regulatory and tax burdens, the weak rule of law, heavy bribery, and an active unofficial economy.
In a later work by S.Johnson, D.Kaufmann, and P.Zoido-Lobaton (Corruption, Public Finances, and the Unofficial Economy. World Bank Policy Research Working Paper #2169,1999) (PDF) it is demonstrated that ineffective and discretionary administration of tax and regulatory regimes, as well as corruption, increases the size of the informal economy. Exploring in detail the role of taxation and bribery and using data from 49 Latin American, OECD, and transition economies, the authors found that the unofficial economy accounts for a larger share of GDP where there is greater bureaucratic inefficiency and discretion, and where firms experience a greater tax and regulatory burden as well as more bribery and corruption. The unofficial economy is also much larger where there is less state revenue and where the rule of law is weak.
Measuring the Quality of Governance
The emphasis on governance in development work requires operationalizing the concept of governance and creating a set of governance indicators.
One approach to creating governance indicators is presented by the WB Public Sector’s web site. The site describes two broad types of institutional measures available for large samples of countries: evaluative measures and descriptive measures. Performance measures provide assessments of the quality of governance. For example, governments are rated with respect to corruption levels, or predictability of policymaking. Process measures describe the institutional "inputs" that produce governance outcomes. Unlike performance measures, process measures have no normative content. One example of a process measure is the average pay of civil servants (relative to the private sector or to per capita income); whether or not the election of national legislators is governed by proportional representation (PR) is a second example.
Another approach to creating governance indicators is presented by D.Kaufmann, A.Kray, P.Zoido-Lobaton (Governance Matters. World Bank Policy Research paper 2196, 1999) (PDF). In this work, the authors identified a strong positive association between development outcomes (per capita income, adult literacy, infant mortality) and aggregate governance indicators. The latter are constructed on the basis of several hundred governance indicators. Primarily measured in qualitative units, these indicators are produced by a range of organizations (commercial-risk-rating agencies, multilateral organizations, think tanks, and other nongovernmental organizations) using polls of experts and surveys of residents, officials, business managers as well as objective data and covering a wide range of topics (political stability and the business climate, the efficacy of public service provision, experiences with corruption, and so on).
The authors define governance as traditions and institutions by which authority in the country is exercised. This definition of governance is used to organize indicators in six clusters:
1. The processes by which governments are selected, monitored and replaced:
Voice and accountability - measures various aspects of political processes, civil liberties, and political rights and the extent to which citizens are able to participate in selection of governments and monitoring of authority;
Political stability and lack of violence - measures perceptions of likelihood that the government will be overthrown by nonconstitutional means.
2. The capacity of the government to effectively formulate and implement sound policies:
Government effectiveness - quality of public service provision, quality of bureaucracy, competence and depoliticization of civil service, credibility of the government commitment to policies;
Regulatory framework - incidence of market-unfriendly policies (e.g., price control) and excessive regulations.
3. The respect of citizens and the state for the institutions that govern economic and social interactions among them:
Rule of law - the extent to which the agents abide by and have confidence in the rules of society – efficiency and predictability of judiciary, enforceability of the contracts, perceptions of the incidence of crime;
Graft - measures level of corruption and related institutional distortions.
Measuring Corruption: Transparency International (TI) 2001 Corruption Perceptions Index
The CPI registers very high levels of perceived corruption in the countries in transition, in particular the former Soviet Union. Scores of 3.0 or less on the scale from 0 (highly corrupt) to 10 (highly clean) were recorded in Romania, Kazakhstan, Uzbekistan, the Russian Federation, Ukraine and Azerbaijan.
TI 2001index, published by the world's leading non-governmental organization fighting corruption, ranks 91 countries. The corruption perception index, which TI first launched in 1995, is a poll of polls, this year drawing on 14 surveys from seven independent institutions. The surveys reflect the perceptions of business people, academics and country analysts. The surveys were undertaken over the past three years and no country has been included in the CPI without results from a minimum of three surveys. |  |