Stylised Facts from the Data

29 Table 2. 1. Summary statistics for key variables

Formal Sector Informal Sector Obs Mean Std. Dev. Obs Mean Std. Dev.

Value added per worker (log) 100 8.44 1.24 122 7.74 0.86 Value added per capital (log) 95 -0.08 1.80 121 2.24 1.33 Capital/Labour ratio (log) 95 8.52 1.37 121 5.51 1.22

Labour costs (log) 95 11.56 1.85 113 8.24 1.03

Firm Size (employment) 100 66.03 92.19 122 3.12 1.50

Firm age 100 34.48 23.23 117 8.55 6.41

Notes: For the formal sector, the summary statistics are only for overlapping industries with the informal sector (Metal, Textile and Wood) for plausible comparisons.

The summary statistics in Table 2.1 shows differences in firm size between the formal and informal sector firms, with the formal sector having average employment of 66 as compared to the informal sector of 3. Firms in the informal sector are on average younger than those in the formal sector. However, value-added per worker (labour productivity) is comparably the same in the two sectors. Noticeably, the formal sector firms have a lower value-added per capital as compared to informal sector firms. This signals that firms in the formal sector produce using substantially higher capital-labour ratios.

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Figure 2. 1. Distribution of firm size for formal and informal sector firms

Notes: Kernel density plot for the firm size as measure by the log of employment. The solid density is for the formal sector while the dashed one is for the informal sector.

Figure 2.2 presents the distribution of value-added per worker (labour productivity) between formal and informal sectors. Several features are evident in the data. There is a wide distribution of value-added per worker across formal and informal firms, reflecting a high degree of firm heterogeneity within each sector. The distributions show that the formal sector firms are, on average, more productive than the informal sector firms as shown by the rightward location of the kernel density function for formal sector firms. Finally, there is a large overlap in productivity between formal and informal sector firms.

Figure 2. 2. Formal and Informal sector valued-added per worker

Notes: Kdensity plot for log value-added per worker for large and small formal firms as well as informal firms. The purpose is to show that productivity overlaps between the formal and informal sector firms.

0.2.4.6.8

0 2 4 6 8

ln(Employment)

Formal Informal

Formal and Informal Sector Firm Size Distribution

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The overlap in productivity shows that many informal sector firms are as productive as their counterparts in the formal sector. There are nevertheless many informal firms that have very low levels of value-added per worker. This again points to substantial heterogeneity in the sample, but also that many firms in the informal manufacturing sector comply with the structuralist view of the informal sector. Lastly, the formal sector distribution has a long tail skewed to the left. Many large firms, therefore, remain in operation despite low levels of productivity.

Market frictions or obstacles are theoretically and empirically well known to be an important source of allocative inefficiency. Table 2.2 presents the proportion of firms within each sector that declare the given obstacles as constraining the growth of their businesses. The results in Table 2.2 demonstrate that financial inaccessibility is one of the major challenges hindering the growth of firms. Unsurprisingly, 57 percent and 78 percent of firms in the formal and informal sector, respectively, declared inaccessibility to finance as a major challenge constraining business growth. The Zimbabwean economy has been, for the past two decades, suffering from high liquidity and credit constraint, such that firms have limited access to lines of credits to boost their business. Interest rates on loans are also very high, discouraging firms from borrowing (Mujeyi, 2016). This obstacle is much prevalent in the informal sector where most firms do not have the required documents to source formal loans from banks.

Table 2. 2. Prevalence of obstacles in the formal manufacturing sector

Formal Sector Informal Sector

Variable N Mean N Mean

Financial Inaccessibility 100 0.57 122 0.78

Electricity Shortages 100 0.14 122 0.18

Lack of government initiatives 100 0.18 122 0.33

Raw materials Inaccessibility 100 0.16 122 0.10

Unfair Competition 100 0.34 122 0.51

Bad Debtors 100 0.06 122 0.03

Insufficient Demand 100 0.39 122 0.56

Labour Regulations 100 0.20 - -

Obsolete Equipment 100 0.10 - -

Lack of Space to Operate - 122 0.20

Notes: Proportions of firms with underlying obstacles in the formal and informal sectors.

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Table 2.2 also illustrates that 34 percent of formal sector firms and 51 percent of informal sector firms have unfair competition as one of the challenges affecting their business operations negatively. Unfair competition largely constitutes competition from cheap imports which are flooding the markets, especially in the textile industry, thereby reducing the competitiveness of domestic firms. Formal sector firms also highlight the informal sector firms as having an unfair competitive advantage over them, as informal sector firms do not pay regulated taxes, and hence are able to lower their prices without incurring much loss. Empirically, unfair competition can reduce the aggregate productiveness of the economy, especially from imports.

Noticeably, there is a strong relationship between unfair competition as a constraint, and firms declaring as having insufficient demand.

Only 18 percent of formal sector firms declare lack of government initiatives as affecting their operations negatively, as compared to 33 percent for informal sector firms. Lack of government initiatives includes government policy inconsistency, counterproductive policies, bureaucracy and other government policies that reduce the ease of doing business by firms. These policies may have a distortionary effect on the market.

Stringent labour market regulations are also a source of hindrances to business growth in the formal sector where firms adhere to regulative legislation. 20 percent of formal firms reported being constrained by labour regulations. These regulations do not allow firms to retrench workers whenever firms deem necessary. The costs of doing so are prohibitively high, resulting in firms employing more workers than is optimal, leading to productivity losses and constraining effective allocation of resources. Some informal sector firms are constrained by a lack of space to operate their business and operate in open spaces with no permanent structures.

They end up incurring huge losses and increased business costs as they try to safeguard their equipment and output from weather conditions and theft. Other constraints facing firms include the shortage of electricity and the inaccessibility of raw materials.

In the next section, we present the empirical results from the HK non-parametric model to determine how the stylised facts presented above fit together to explain the extent of misallocation within and between the formal and informal sector firms and the implied TFP losses.

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