Informal sector, policy reform and structural transformation

The paper examines the roles of small and medium enterprises and the informal sector in the context of economic growth and structural transformation, with special reference to Latin America. It finds that the "remarkable convergence of views" is to some extent based on misinterpretation and that some of the policy inferences that have been drawn are wrong. The record of employment and productivity growth in Latin America is reviewed. Compared to other countries at their respective income levels, Latin American countries have less employment in agriculture. There is much low-productivity employment in the industrial and service sectors, despite relatively rapid employment growth in industry. Structural transformation in the region has been suspended as a result of policy choices such as chronically overvalued exchange rates, high levels of effective protection, high tax rates combined with measures of tax relief which encourage the use of capital, labor protection laws, interventionist financial policies, and pervasive government regulation of economic activity. Prospects for reforming these policies to permit accelerated growth and transformation are reviewed. The real cure for urban dualism, which has labor market and enterprise aspects, is development. Dualism gradually disappears as economies grow and generate sufficient demand for unskilled labor. Most of the workers employed at low-productivity levels in small or informal enterprises in low-income countries eventually find work in larger enterprises. Although many small enterprises survive in rich countries, most of them aim only at providing a livelihood for their proprietor and his/her family; many fail even to do this, going out of business after a few years at most. A few, however, thrive and grow, providing not only productive employment but a vital element of flexibility, innovation and competition to the economy. Policy should encourage both structural transformation and the participation of progressive small and medium firms in this vital process. (Author abstract)