The Arab world is known for its rich history and diverse culture. Yet, it faces significant hurdles on its path to economic development. In the last two decades, the Arab region has experienced below-average economic performance compared to the bloc of low and middle-income countries. From 2000 to 2019, the annual growth rate of gross domestic product per capita was 1.7 percent on average, significantly lower than the growth rates observed in many Asian countries. In other words, the Arab region has fallen behind, and income disparities with other developing regions have widened.
The ongoing discussion about the role of the informal economy has gained increased importance. Although the informal economy exists in many parts of the world, it is particularly present in the Arab world, where it represents an average of 26% of GDP and provides employment to 68 percent of the labor force, one of the highest rates of informal employment. This phenomenon can be attributed to various factors, including corruption, limited property rights, bureaucratic obstacles, and limited financial access, all of which discourage entrepreneurs and workers from participating in the formal economy.
The origin of the informal economy in the Arab world
In the Arab region, the informal economy is a natural response to restrictive regulations and high barriers to entry in the formal sector. Informality arises from incentives created by a lack of proper legal and regulatory frameworks. Businesses choose to operate informally on a smaller scale to avoid high taxes and regulation and be more flexible with their workforce. If firms and workers perceive few benefits from formalization, or these benefits are low compared to informal alternatives, informality will remain high.
After gaining independence, the Arab governments were committed to offering employment opportunities in the public sector, free education and healthcare, and subsidized food and fuel. In return, citizens were expected to remain silent and accept a certain level of repression and distortions (privileges) in the private sector. However, the region’s modest economic growth resulted in low numbers of job opportunities in comparison to the size of the working-age population. The Arab region had the lowest employment-to-population ratio in 2019 (38.2 percent), the lowest female labor force participation rate (19.5 percent) and the highest youth unemployment rate (27.9 percent). As a result, individuals sought refuge in the informal sector, which functions as a form of social protection, especially for individuals with limited skills, youth, and women.
The informal economy is flexible, cost-effective, and highly entrepreneurial. Nevertheless, these businesses often struggle to obtain credit or alternative financing options, which limits their growth potential. At the same time, workers are vulnerable to mistreatment by police and local authorities.
How to formalize the informal economy in the Arab world?
The Arab region faces challenges like restrictive regulations, heavy state-owned enterprises (SOEs), and cronyism, hindering fair competition and leading to concentrated markets. The SOEs presence and monopolies discourage private firms from registering with the official authorities or entering markets. For instance, the SOEs presence in some Arab countries extends to 41 sectors in Egypt, 23 in Morocco, and 40 in Tunisia, compared to an average of 26 sectors in developing countries. Moreover, enforcing commercial and credit contracts is challenging. Resolving disputes is slow and costly due to inefficient court structures and procedures, poor case management, and a lack of automation and alternative dispute-resolution options. Borrowers and lenders have weak protection in the Arab region, with Egypt, Morocco, and Tunisia scoring poorly on the World Bank legal rights index, 5, 2, and 3 (out of 12). In the end, small firms can hardly access the credit market.
Much is to be done. Policymakers should concentrate on lowering barriers to entry in the formal sector and creating incentives for innovation and productivity. Property rights should be defined properly and enforced. Moreover, business registration procedures should be changed, State-Owned Enterprises (SOEs) privatized, the tax code simplified and the labour market undergo drastic reforms. Failure to take action will soon unleash political tensions of all sorts.
Photo by Jean Carlo Emer