Why the Digital Economy is Key to Formalizing Africa's Informal Sector

Etop Ikpe is CEO of Cars45.
14 September 2017
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African Expert Network (Washington, DC)

Lagos — At a recent conference, newly elected French President Emmanuel Macron proclaimed that he wanted France to be a "start-up nation." From Washington to Paris, start-ups are heralded as the key to catalyzing economic growth. But in Africa, home to the highest number of people in early-stage entrepreneurship, the hustle and drive of up-and-coming businessmen and women isn't always matched by productivity and profits.

With the commodities crisis crippling the economies of countries like South Africa and Nigeria, it's become more important than ever that Africans develop the blueprint for their own start-up nations. While industrialization is an appealing path to growth for countries like Ethiopia, more nations should value the developmental potential sitting in front of them: Africa's large informal sector.

For Africa's young population to be an opportunity instead of a demographic challenge, the public and private sector must partner to formalize the existing economy. By leveraging technology, African countries can enhance understanding of markets, expand education and employment, and deliver monetary benefits for the informal sector and government alike.

The digital economy offers Africans an opportunity to re-align markets by eliminating information asymmetry. Unless businesses in the informal sector are able to connect with consumers, the SMEs that make up the backbone of Africa's economies will be selling in the dark. On average, the productivity of Africa's informal firms is only 25 percent that of small formal firms and 19 percent of medium-sized formal firms.

By providing more accurate data for customers, digital services can improve services and introduce more stability into the region's volatile markets. Today's consumers use their phones for almost every service imaginable. Through technology, more SMEs can better monitor and cater to consumer needs and wants, and reach the customers they want. Some businesses across the continent have already developed innovative ways to use technology to help informal SMEs better understand local markets.

Bel, Orange Labs and Orange Côte d'Ivoire are currently partnering to leverage telecom networks to track informal distribution routes of street traders. In Kenya, MFarm empowers Kenyan farmers by providing up-to-date market prices and direct access to buyers. In Nigeria, my own company, Cars45, is digitizing Africa's billion-dollar used-car economy by enabling customers to sell their cars safely and securing in less than an hour. These digital tools will eventually revolutionize the management of informal business distribution networks.

Across Africa, informal sectors provide employment to over 66% of the population, especially women, youth, and the working poor. Even as the region attracts over $50 billion in foreign direct investment each year, 8 out of 10 Africans work in vulnerable forms of employment. The continent's working age population may be rapidly growing, but it hasn't managed to keep pace with official employment — meaning that more people each day find themselves hustling in the precarious boom-and-bust nature of informal work.

These workers are often more focused on getting by than on growth. However, as smartphones and Internet access expand across Africa, technology empowers the informal sector by creating scalable platforms that provide them with more secure income, employment benefits, and social protection. In South Africa, for example, cleaners are traditionally found through agencies, referrals, or classified ads — an inefficient process for customers and cleaners alike. In 2014, however, SweepSouth created an on-demand service that connects over 3,000 domestic cleaners directly to customers. While SweepSouth has introduced more pay and flexibility for cleaners, the model could be expanded to countless other informal industries from childcare to maintenance.

Beyond market knowledge and access, digitization creates a pathway to formalization that is a win-win for businesses in the informal sector and governments alike. In the past, the costs of coming out of the shadows may have outweighed the benefits for SMEs in the formal sector; however, technology can ease the burden of regulation by streamlining bureaucratic processes.

Moreover, it can generate greater visibility to donor and government services such as skills training and access to finance. With legal recognition, governments can better improve access to capital, award contracts to SMEs, and counsel them on business development. Although governments and development agencies increasingly recognize the importance of support for SMEs, efforts to engage them are more likely to be successful through coordinating agencies like Nigeria's Small and Medium Enterprise Development Agency or South Africa's Department of Small Business Development. By using technology in their outreach to SMEs, these agencies can better connect and serve more small businesses.

For resource-strapped governments, formalizing the informal sector via technology also provides an opportunity to rapidly expand national tax bases through easily traceable methods. Better data on these unregistered businesses may also attract more investors as Nigeria witnessed when it rebased its GDP in 2014. When Nigeria accounted for formerly omitted sectors including the informal economy, its GDP rose more than 89 percent, which caused global investors to sit up and take notice. The same might hold true for Senegal, a country currently in the midst of rebasing, where the informal economy is estimated at more than 40% of GDP.

Generating more productivity and mobilizing greater revenue for the businesses are the bottom of the pyramid becomes increasingly essential in light of Africa's rapidly growing and largely unemployed youth population. By leveraging technology, we can introduce more consolidation, quality control and innovation into the informal sector. With the informal economy making up 55% of Africa's economic activity, increasing productivity gains could mean unlocking the continent's El Dorado.

Etop Ikpe is CEO of Cars45

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