From informal to formal and back: Theoretical reflections on the formal – informal divide in the Base of the Pyramid market


In understanding the nature and the dynamics of poverty in African societies, and their interplay with the creation of sustainable development paths, we argue that a deep understanding of the processes of the so-called informal economy is necessary. The informal economy is not a static concept that describes an isolated sector of the society, but it has complex and fluctuating relations with the so-called formal sector (Guha-Khasnobis, Kanbur, & Ostrom, 2006; Holt & Littlewood, 2014; Kanbur, 2009; Portes, Castells, & Benton, 1989). The interplay between the formal and informal dimensions has consequences at different levels, such as the labour market, product development, outcomes in terms of income diversification, and food security. Such reflection would benefit from the simultaneous consideration of theoretical contributions from different disciplines, such as economics, economic sociology, and anthropology (see, among others, Biggeri, 2004; De Soto, 1989; Hart, 2009; La Porta & Shleifer, 2014; Loayza & Rigolini, 2011; Meagher, 2018; Portes & Haller, 2005).

Among the many definitions of informality, we consider a broad one for which the informal economy is the sum of production and distribution activities of goods and services that are excluded from the national accounting (Portes & Haller, 2005). We recall that Chen (2012, 8) identifies two sub-groups of entities within this broad definition. The first is the informal sector, represented by “the production and employment that takes place in unincorporated small or unregistered enterprises”, while the second is the informal employment, which refers to “employment without legal and social protection — both inside and outside the informal sector”.

The debate on the relationships between formal and informal sectors has the potential to inform fruitfully the Bottom of the Pyramid (BOP) narrative for different reasons. First, a significant BOP feature is the strong role played by the informal sector and by the informal employment opportunities for livelihood and income generation (Hammond et al., 2008). Second, according to many scholars, successful development of BOP markets is dependent on strategic and effective interactions between stakeholders from the informal domain and

Reflections on the formal — informal divide 229 actors of the formal sphere, who are mainly represented by private enterprises of different sizes. Third, the BOP narrative builds partly on the idea about a natural tendency of small informal actors to innovate as a means of escaping poverty (Anderson et al., 2010; Linna, 2012; Meagher, 2018). Consequently, a more specific (and critical) understanding of this idealised “natural” innovation process can improve the BOP narrative.

The first wave of the BOP literature was more focused on considering low income individuals as potential customers of the formal economy (Hammond & Prahalad, 2004; Karamchandani, Kubzansky, & Lalwani, 2011). Subsequently, the BOP debate turned to see the poor, often engaged in informal economic activities, as potential entrepreneurs, given their supposed “natural" tendency to innovate in order to improve life conditions (Linna, 2012). We aim to contribute mainly with this second aspect of the discourse. However, a placement of the BOP scholarly discussion within the wider debate on the informal economy and its interconnectedness with the formal sector, beyond the managerial approach, is still missing, and it is this gap that we aim to fill.

We argue that the distinctive elements that lead to an enthusiastic consideration of BOP market opportunities, such as tendency to innovate, strong networks, and knowledge of the territory (Anderson et al., 2010; Meagher, 2018), are in reality part of the dense interactions between the wider formal and informal sectors in a complex economy. Therefore, it is the modality by which the BOP environment is inserted in the formal economy that determines its dynamics and results. The unavoidable connection of the informal economy with formal companies, regulations, and markets influences why and how individuals enter the informal BOP sphere, and whether they are able, or willing, to escape it. In this chapter, we investigate whether a deeper analysis of specific informal settings and their relation with the formal domain improves the understanding of the actual impact of this interaction on the BOP environment. In order to do so, we start by classifying theoretical contributions on informality into categories. Furthermore, we apply these frameworks to two cases that have been extensively studied in the literature. For each case, we consider the peculiar features of the formal — informal interaction, and we wonder which are the actual positive and negative consequences for the BOP stakeholders.

Methodologically, we provide a review of the empirical literature on two African case studies that represent examples of the different approaches used for interpreting the formal — informal interaction. In reviewing some theories on the formal — informal relations, we focus on the interdependence of the two domains and, more particularly, we highlight two approaches. The first considers such interactions as structural in contexts where the two domains have undefined boundaries; they are typical of complex economies in which articulated value chains of production and distribution are present (Chen, 2012; Portes et al., 1989). The second interprets formal - informal interactions as the result of individual strategies in dealing with both domains separately, according to their needs and opportunities (Banerjee & Duflo, 2011; Biggeri, 2004;Toulabor, 2012; UNCTAD, 2015).

We review the empirical literature on two case studies that illustrate the two theoretical perspectives mentioned above. The first case deals with the emergence of the mobile money market in Kenya (lazzolino, 2017; Maurer, 2012; Meagher, 2018). It shows how large formal companies commercially exploited the opportunities offered by informal networks, knowledge, and practices, and created a system in which BOP informal actors are at the same time consumers and co-creators of innovation. The related literature presents successes and contradictions of these systems in which, despite the undeniable overall achievements, the large formal actors benefit the most, and the profit margin for the BOP stakeholders diminishes. The second case focuses on Ethiopia and investigates the relationship between the formal labour market and BOP small-scale entrepreneurship (Bigsten, Kebede, & Shimeles, 2005; Blattman & Dercon, 2017; Chinigo & Navarra, 2017; Rossetti, Chinigo, Navarra, & Argaw, 2015). In this case, formal and informal sectors are both active but coexist on parallel routes, and both are used in complex livelihood strategies; workers seem to enter the self-employment sphere as a reaction to the imperfections of the formal labour market, and this process produces a path of informalisation and an enlargement of the BOP sphere. This path contradicts the expected formalisation dynamics that should come along with economic development.

The two cases are comparable in the sense that both show how the informal sphere remains strongly present, even in the case of important economic and societal changes in African countries, and how this sphere remains populated by BOP stakeholders. Moreover, in both cases, the informal domain is not insulated but strongly interacts with the formal one. The cases differ in the way in which interdependencies between the two sectors are articulated.

Section 2 presents the theoretical background on the formal — informal divide, first in a historical perspective and then focusing on each of the two selected theoretical approaches: structural relations between the formal and the informal sector and the individual agency perspective. Sections 3 and 4 present the empirical literature on, respectively, the development of mobile money in Kenya and the relationship between micro and small enterprises and the formal labour market in Ethiopia. In Section 5 we conclude the chapter by highlighting the implication of these reflections for future research streams and decision-making.

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