Does the large informal economy of Ghana mean anything?

The Ghana Statistical Service (GSS), in its recent 2024 national report, titled “Productivity, Employment and Growth,” revealed that Ghana’s informal economy has become the country's mainstay. Approximately 92.3% of all businesses in Ghana are informal, accounting for 27% of the country's GDP [GSS Report]. However, the informal economy, which employs approximately 80% of the Ghanaian workforce, contributes only a quarter of the nation’s GDP, highlighting the apparent challenges of the sector.

Undeniably, having a large share of economic activities in the informal economy does not support sustainable development. However, for many developing and transition economies, the phenomenon of economic formality is a grim reality. Approximately 2 billion people are currently employed in the informal economy worldwide. Although the size of informality tends to decrease as countries develop, it remains an integral part of many African countries.

The informal economy is best defined as encompassing activities conducted in a lax legal environment with no barrier to entry or exit. Their lawfulness or otherwise, in most instances, has nothing to do with the activities being undertaken, but rather with the legal status of their businesses.

Given the size of Ghana's informal economy, it cannot be ignored in the policy discourse context concerning sustainable economic transformation and inclusive development. Unlocking the full potential of the informal sector could have a positive impact on public policymaking, improve tax administration and domestic revenue mobilisation, and enhance the accuracy and effectiveness of targeted government interventions. Additionally, their effects on income levels and poverty alleviation, especially among vulnerable groups, cannot be omitted.

Despite the glaring benefits of formalisation, the unique characteristics and challenges of Ghana's informal economy require a nuanced approach to navigating them. It presently plays a crucial role in providing goods and services, including, in some instances, essential ones, in areas where formal businesses are not feasible due to considerations of economies of scale.

These realities underscore the need for caution in designing policies aimed at formalising the sector. Formalisation could lead to a high tax burden, raise operational costs, and impose extensive reporting requirements for those who decide to formalise. Studies have shown that 'suppressing informal activities through laws - and, in recent years, through policy pushes toward ‘formalisation’ - are unlikely to be beneficial.' This underscores the need to optimise gains from the current structure rather than change it entirely.

It's crucial that policymakers, in the immediate term, focus on addressing the challenges faced in the informal economy. These include unsafe and unhealthy working conditions, low productivity and skill levels, a lack of standardisation, and limited access to business support. By paying close attention to these issues, we can improve the quality of productivity of the informal economy and enhance its contribution to Ghana's overall growth. The need for caution in formalising the sector should prompt policymakers to be prudent in their approach, understanding the weight of their decisions and the potential impact on the economy in the immediate term.

Admittedly, formalising the informal economy is required for its apparent benefits. However, we cannot ignore the significant hurdles that lie in this transition. The incentive for formalisation lies with the government rather than the informal actors. The government stands to benefit in terms of improved revenue mobilisation and effective policy planning. However, the present architecture requires that the cost of formalisation is borne entirely by informal businesses, who are resource-constrained. Additionally, despite the generally low educational levels in the sector, there is no simplified business registration or tax filing system in place for informal businesses.

There is also not enough information on the benefits that informal businesses stand to gain after they formalise their operations. These constraints cannot be whitewashed if Ghana is to transition the informal economy sustainably. Formalisation efforts must be novel and, more broadly, serve as an enabler of ideation fertilisation between formal and informal actors.

Given the cost of formalisation, efforts in the immediate term must be geared towards optimising the potential of the informal economy. The lax entry and exit, due to limited or no registration requirements, makes the informal economy a quick fix for the growing unemployment situation, especially among the youth. The low capital requirement makes it easy for anybody to start a business of their interest at any point in time. It suffices to note that informal business owners are rational and will only invest capital in sectors with the potential to generate returns. They may not contribute as much to economic development as formal businesses, but they remain relevant as long as they provide employment and services to underserved communities.

The momentum for formalisation rests with the State, and the government must take the first step. This requires harmonising the numerous laws and regulations governing business registration and streamlining the often-complex registration processes.

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