Poverty and the Informal Economy

Human development and human rights share a common vision and purpose: to
secure the freedom, well being and dignity of humanity. Human development is
as essential for human rights as the latter is for the former. Historical evidence
suggests that the more civilised societies were those that gave a higher priority
to both, for example, the Greek, the Roman and the enlightened years of early
Islam. The freedom from want is perhaps the one inalienable right of humanity
which stands between dignity and indignity and which must be mitigated against
by both state and individuals. The first informal recognition of this lies in the
alms-giving encouraged by all religions and beliefs, and was formally codified by
Islam through zakat and ushr (a form of redistributing wealth and agricultural
income respectively) as a religious duty [the Quran]. In fact, this was applied
with such zeal, and the partnership between state and individual was so effective
that in the days of Caliph Umar Farooq (634-644 AD) the collections from zakat
and ushr could not be distributed as no one could qualify as a mustaheq
(deserving poor). The state system was unfortunately allowed to lapse.
Individual and private efforts to mitigate poverty and endow the poor with social
capital, however, continued throughout the Muslim comity.

The poor are generally perceived to be those who are deprived of opportunity
and poverty is explained by individual circumstances and/or characteristics of
poor people. The poor are those who face deprivation of common necessities
that determine the quality of life, including food, clothing, shelter and safe
drinking water. They also face deprivation of opportunities to learn, to obtain
better employment to escape poverty, and/or to enjoy the respect of fellow
citizens. Stated differently, to be poor is to be deprived of those goods and
services and pleasures which others around us take for granted. Poverty is
perceived as the state of being poor.

The lessons from history clearly establish that for improving the social
endowment of the poor both the state and the individual are key players; money
is a necessary requirement; good governance is critical to success and the
participation of each component of society as a whole ensures sustainability and
continued benefits beyond the initial attempts to mitigate the impact of poverty.
In other words decentralisation is a key element to improve the lot of the people,
particularly the poor and the disenfranchised. This is so because it the
community which has much greater insights into who are poor and who are
disenfranchised.

Governance is generally conceived of as the exercise of economic, political and

administrative authority to improve the quality of life of the people. It is a
continuing process where divergent opinions and desires are satisfied through
compromise and tolerance in a spirit of cooperative action for the mutual benefit
of the larger whole. It has three dimensions: one, the political regime; two, the
systems and procedures for exercising authority; and three, the capacity of
governments.

The basic objective of good governance is to improve the quality of life of people,
to ensure that their needs are met equitably and that disparities in income are
reduced over time and is best attained through the effective participation of
people, that is through decentralising the apparatus of the state to the closest
level to people, namely local governments. The incidence of poverty is one
measure of whether governance in any nation or state is good or bad. Poverty
has been rising over time in Pakistan and is currently estimated to include about
44 percent of the population. While the mass of the numbers are in the rural
areas, extreme poverty is more evident in the urban areas. This is largely
because the poor in the rural areas continue to have food security which is
denied to the urban poor.

Politics is about the creation and distribution of power, be it within organisations,

tribes, communities or society at large. Governance is the mechanism which
controls the relationship between the two extremes—the governed and the
governors. The political process lies at the core of governance and this can be
said to be efficient only if elections are free and fair; the elected are
accountable, authority is divided between the legislature, the bureaucracy and
the judiciary; and, power is decentralised.

Poverty is an outcome of the interaction of economic, social, legal and political

processes mediated through a range of institutions. By removing these barriers
to poverty reduction, the state can help to empower the poor to improve their
lives. The interaction between the quality of governance and democracy, the
rule of law and the extent of devolution, decentralisation and autonomy
determine the success of state institutions in being "pro-poor." In essence,
therefore, there are four ingredients in the relationship between governance and
poverty: one, democracy, two, the rule of law, three, bureaucratic performance,
and four, pro-poor institutions.

In any society the key dimensions to poverty are both being unheard and
powerless. Democracy requires one, regular and peaceful elections; two, highly
inclusive participation by all; and three, freedom of expression, of the press, to
form and join organisations, and to information. It is argued that democracy will
reduce these barriers to poverty eradication through empowerment. However,
this is not necessarily achieved, principally because the poor are excluded from
access due the lack of education, knowledge, opportunity, economic power,
information, etc. Unless elected to local office the likelihood of the poor having
access to the elected is non-existent. Thus the poor need a direct voice in the
interventions that affect them on a day to day level, and to build up their assets
to prevent their exclusion. On the other hand, democracies appear to be more
favourable for the income, health, and education dimensions of poverty. Further,
a free press can create awareness in the public and increase transparency and
accountability in governance. This in turn helps in reducing corruption, reduces
the arbitrary use of authority and increases the potential for meeting the needs
of the poor. All of which combined contribute to higher rates of growth.

The debate on the causes, effects, extent of, and the best ways to measure
poverty, directly influences the design and implementation of poverty-reduction
programmes. At the official level in Pakistan poverty reduction programmes
have included the distribution of Zakat funds collected by the Federal
Government through local Zakat Committees, the Distribution of Bait-ul-Maal
funds through identification of the recipients by the local councils, the various
versions of public works programmes delivered through the local governments,
the distribution of micro-credit through local NGOs, and the latest experiment is
through food stamps and higher cash transfers. However, the most extensive
support to the poor is provided by cash transfers privately as Zakat, Khairat and
Sadaqa by the wealthier segments of society and through employment in the
informal sector of the economy.

The latest studies on the informal economy estimate that Pakistan’s informal
economy is believed to have grown to be more than half the formal economy
which yields a GDP of $166 billion. One report says that it has reached such
proportions that it was upsetting public welfare plans. The report puts its size at
$83 billion and that it could yield the national exchequer revenue of $8 billion if
taxed even at 10 per cent. But there is a belief that the country’s parallel
economy has already touched $100 billion. To determine the size of the informal
economy is problematic simply because there is nothing on paper. According to
an assessment, the underground economy expanded at the rate of 9 percent
annually between 1977 and 2000. Since then it is estimated to have grown by
nearly 11 percent annually. These rates are a much higher rate than the formal
economy.

The informal economy helps its sections make easy profits since wages are
below minimum wages prescribed by law. The informal economy grows along
with corruption, speed money, smuggling, narcotics, and tax evasion as these
are all cash based. Only recently, hoarders and speculators of staple food
commodities like rice and wheat were able to make a killing by their covert
activities with the active connivance of officials, both elected and appointed.

No government has shown nerves to tackle this problem. Every government at

some stage initially takes a serious view of the situation but then decides to offer
incentives to whiten the black money/assets. The informal economy (which also
includes the “black” economy) is, of course, a global phenomenon. The
Economist, London, for instance, estimated that in 1998 the world’s black
economy was about equal to the output of the United States.

While most of the underground economy elsewhere in the world revolves around
criminal or illegal activities, the major contributors to the black economy in
Pakistan are legal businesses and the government. Legal businesses controlled
by the government, government expenditures and taxes have also been the
“major source of black-money creation.” For instance, no real-estate deal in the
country is done without the involvement of at least 40 per cent unaccounted-for
money, and a large portion of the billions of dollars in foreign exchange inflows
that Pakistan sees every year is actually the returning black money that went out
of the country in the high-tax regime before liberalisation began.

One study shows that the informal economy is not just the unregistered street
vendors and tiny businesses that form the backbone of marketplaces in Asia and
other emerging markets. It includes many established companies, often
employing hundreds of people, in industries as diverse as retail, construction,
consumer electronics, software, pharmaceuticals and even steel production. In
India, Pakistan, Indonesia and the Philippines, as much as 70% of the non-
agricultural workforce is employed in informal businesses, thereby contributing
to minimising poverty in the cities and towns.
Despite the prevalence of the informal economy, policymakers in Pakistan show
surprisingly little concern. Governments argue that it helps relieve urban
employment tensions and will recede naturally as the formal economy develops.
However prima facie evidence suggests that informal companies themselves will
grow, modernise, and become law-abiding if given some help.

The reasons why informal economies grow – and keep growing – are not hard to
uncover: high corporate tax rates and the enormous cost of doing business
legally. In Pakistan there are more than two dozen agencies of government
impeding legal business activity. Only the police impact on the informal
economy. All in all, legal businesses face administrative costs three times as
high as their counterparts in developed economies. No wonder so many choose
to operate in the gray.

The costs imposed by the informal economy are not limited to the hundreds of
millions in foregone tax receipts; more damaging is its pernicious effect on
economic growth and productivity. The unearned cost advantage informal
businesses enjoy from ignoring taxes and regulatory obligations allows them to
undercut prices of more productive competitors and stay in business, despite
very low productivity. Informal apparel makers in Pakistan have an estimated
25% cost advantage over their law-abiding competitors by not paying taxes or
adhering to labour laws.

While it may be argued that reducing the size of the informal sector would
enable government to widen the tax base and thereby provide money for long-
term programmes for sustained poverty reduction, the proponents for the
informal sector state that this is not true. They point simultaneously to the
substantial increase in tax revenues and also to the increasing levels of poverty
caused by this. They argue that reduction in taxes alone will not induce the
reduction of the formal sector.

It can be argued that assisting the informal sector to contribute more to poverty
reduction would require the legislators to:
• Encourage the government to reduce that tax rate of small businesses to
less than a quarter of the existing corporate rate,
• Improve the tax-paying culture by taxing all segments of the economy,
• Streamline regulatory procedures,
• Simplify the tax laws, for instance giving small businesses the option of
calculating taxes based on physical characteristics, such as a store's
square footage, rather than reported revenue, which is difficult to verify.