According to José Juan Ruiz, chief economist of the Inter-American Development Bank, informality could soon become a major problem for Latin American countries due to its negative impact on productivity. This outlook is similar to a report made by the McKinsey Global Institute, which states that, since the signing of the North American Free Trade Agreement, Mexico has been divided into two parts: on one hand, it appears to be a vigorous and innovative economy with large and modern companies, whose productivity increases at 5.8 annual rates; and on the other hand, there is a lethargic economy full of medium and small companies, some which are traditional whilst some are informal, and whose productivity is dropping by 6.5% each year. That way, both visions highlight the following question: can this really be called the “Mexican moment” when most of the country is paralyzed by informality and unproductiveness?
Informality is an ancient but amazingly little known issue. There is not a unique definition that embodies all the economic activities that are part of it. Some people consider it as all illegal activities that are legitimate for a major part of society. For instance, this definition includes piracy, undocumented workers as well as tax-evading companies but excludes drug trafficking. It also includes thousands of legally established enterprises that do not have any possibility or incentive to grow given the current regulatory environment. Family and community companies, housework and self-employment are not informal activities per se, but can fall under the aforementioned category. Precisely due to their nature and size, it has become increasingly complex to make a distinction between what is informality and what is not. There are legally established companies that operate under all legal terms but that gain access to products, services or employees using informal ways.
The impact of informality is quite clear. It does not pay any taxes and, thereby, does not contribute to the providing of public goods and services such as infrastructure and transportation. Additionally, by operating outside legal boundaries, informal companies not only lack access to credit but also find themselves with a vicious cycle of low incentives to innovation that slow the national economic growth. Beyond a social and tax reform that, unlike its promises, it actually creates more incentives for informality, why could other measures undertaken by the current government might fail?
The decision of an individual to enter informality is based on a cost-benefit analysis that is highly determined by the opportunities provided in a specific institutional framework. When institutions in a country are weak, as is the case of Mexico, centralizing politics and economic using a discretionary power to allocate resources – as this administration has done- produces inefficient results that only tend to increase corruption. That way, a society that perceives less support from formal institutions and a government operating a budget with little transparency feels less inclined to follow social norms that involve paying taxes. Without the creation of a culture where a bilateral relation between government efficiency – taxpayers complying with their duties in exchange for more and better services provided by authorities – and incentives for not taking advantage of legal loopholes – and the absence, apparently premeditated, of legal opportunities to breach and continue not paying taxes, tackling informality will keep on being more of a farce where authorities simulate that they’re doing something about it, while society does not comply with the law and benefits from it. If this is the case, informality will remain as everyone’s best short-term option, along with its several long-term negative effects.
What is most worrying about this scenario is that informality seems destined to keep increasing, since it has come up as the natural result of an economy of two issues; a sort of equilibrium where each player has their strategy already defined: the government, with its centralizing policy, and society, trying to find a convenient short-term escape. If the McKinsey analysis is correct, the consequences for not tackling the causes of informality and changing those circumstances that enable it is that the growth limit for the economy will end up being of a mere 2%. Governments are assessed by their results rather than their objectives and, in this case, such a result is nothing short of pathetic.
CIDAC
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