Formalizing the “informal” sector may intensify market fragmentation and trading inequalities (Senegal Edition)

This is from a fascinating paper by Abhit Bhandari, a PhD candidate at Columbia:

Economic growth requires confidence in the secure exchange of goods. But when states selectively enforce rule of law, political considerations can moderate the trust that buyers have in sellers. How do political connections moderate economic behavior in developing countries, and how do such connections operate alongside formal state institutions? I propose a theory of seller moral hazard in exchange, where buyers believe that politically connected sellers can break deals with relative impunity. In this context, state-backed formal contracts may only protect the claims of connected buyers who similarly receive preferential treatment from the state.

I test this theory in an environment with real economic stakes by creating and operating a legal business in Senegal, and hiring employees to conduct door-to-door sales. In a field experiment, I randomize whether my employees signal their political connections and/or offer formal contracts as part of the deal. Results show that sellers’ political connections decrease trust in exchange while formal contracts increase trust. Taking buyers’ connections into account, however, shows that asymmetric political connections impact willingness to trade, and that formal contracts boost trade only for politically connected buyers (emphasis added). These findings demonstrate the importance of unequal political connections in impeding trade, and the limits of piecemeal legal solutions. Exchange under such conditions can result in distinct trading networks that intensify inequalities.

Oh, and to get the study going Abhit registered a business in Senegal:

In preparation for the experiment, I undertook the process of creating and registering a formal business in Senegal. I completed the process in 2016 at APIX, Senegal’s primary agency for the promotion of investment and major works, which is also home to Senegal’s guichet unique (one-stop 20 shop) for formalizing a business. Despite the “one-stop” shop, the process took approximately one month from start to finish, as registering the business required the acquisition of certain documents that are not centrally controlled. This required visits to my local chef de quartier (neighborhood chief), police department, and the Ministry of Justice. The result of the process was the successful formalization of the business and the receipt of a unique business identification number called the NINEA (numero d’identification national des entreprises et des associations). NINEAs are commonly understood in Senegal as proof that a business is formal.

I highly recommend reading the paper. Abhit’s other ongoing projects are available here.

screenshot2019-01-31at9.02.58pmInspired by Yuen Yuen Ang’s take on the institutional structures that shepherded China’s takeoff, I have recently been thinking more seriously about what “optimal” institutions (as opposed to some notion of “strong” institutions) in specific developing country contexts would look like. With this in mind, Abhit’s paper offers an important insight into the potential pitfalls of lukewarm reforms — in this case the process of sectoral formalization. A common mistake made by most would-be reformers is the total disregard for forms of organization that make business transactions credible in the “informal” sector in the name of imposing a state-centric rule-based systems. As Abhit finds, the usefulness of formalization crucially depends on whether it also serves to level the playing field and expand the extent of firms’ markets. I for one think that the distinction between “formal” and “informal” sectors tell more about states’ fragmented regulatory capacity than about specific firms or sectors.

More broadly, I would argue that the world would be a better place if we knew more about firms in low-income states. What policy interventions can help accelerate firm growth? What management practices work in contexts where labor is insufficiently specialized (for insurance purposes)? Is firm-level productivity in Nigeria, Kenya, or Angola improving or not?

(If you know any works along these lines the comments section is open)


What explains voter turnout inequality across the world?

We find that in countries with a high degree of bureaucratic capacity (i.e. ability to tax the rich), the wealthy turn out at higher rates than the poor. Consistent with our theory, we find that the turnout of the poor is largely unaffected by bureaucratic capacity. This finding is robust to a variety of measures of state capacity. We also provide evidence for an additional implication of our theory. If turnout rates amongst the wealthy are driven by their potential tax exposure, it ought to be the case that where redistributive politics on a tax-and-transfer dimension are salient, the rich turn out to vote at higher rates than the poor. We show that where the rich and the poor support different political parties, the rich turn out to vote at higher rates. We also provide evidence that likely confounds, reverse causation, and social desirability bias in reported turnout cannot account for the patterns we find in the data.

That is Kimuli Kasara and Pavithra Suryanarayan of Columbia [h/t monkeycage] in a paper explaining global variation in turnout rates by income. In a roundabout way the paper speaks to the factors that enhance democratic stability. Low state capacity (in this case with regard to tax collection) is bad for democratic stability because, among other things, it denies young democracies the stabilizing effect of the middle and upper classes in the democratic process thereby making them continue to behave like autocracies (Did you know that autocracies in Latin America redistributed land more than democracies?) It also takes away the taxation-based implicit contract between the voter and the state, thereby giving politicians a free hand to do as they wish with public resources.

In related news, following the US Supreme Court decision on the Voting Rights Act Rebecca Onion at Slate posted a nice piece on the original literacy tests in Louisiana that were designed to keep minorities away from the polling stations. Interesting stuff. I wonder what the average score would be if the tests covered all voting age Americans…