Why are there so few Indigenous firms in the formal private sector in Africa?

Event Title: Why are there so few Indigenous firms in the formal private sector in Africa?
Sponsor: IRG Africa Roundtable
Location: IRG Conference Room
Date: November 20, 2006
Time: 12:30pm-1:45pm
Approximate number of attendees: 30
Intern attending: Ava Jones

Speakers: Dr. Vijaya Ramachandran, Assistant Professor of Public Policy at the Georgetown Public Policy Institute (GPPI).

Using data from the World Bank, Dr. Ramachandran sought to answer two key questions: 1) what are the differences between indigenous and non-indigenous firms and 2) what is constraining the movement of small, indigenous firms from the informal to the formal sector. The private sector is dominated by ethnic minorities in Africa. The private sector is also “highly dualistic”. There are either small, informal firms which are very volatile or small, medium, large, or very large firms that are formally registered. There are no firms in the middle. Small firms are defined as having 10-49 employees.

Indigenous firms are disadvantaged in comparison to other firms because they are smaller when they start. For black Africans, their firms are the smallest of all the minorities. However, the poor investment climate affects all firms. Issues such as power, water, energy, and output lost to power outages place a greater burden on smaller firms because it is harder for them to respond. Credit is also a problem because it is sometimes a binding constraint. The percentage of indigenous firms receiving trade credit (working capital) is lower than ethnic minorities. This is a function of the fact that it takes them 10-15 years to build relationships with suppliers. Dr. Ramachandran posits that university educated black African entrepreneurs start bigger firms and are able to sustain a higher rate of growth because of access to a network.

Several factors contributed to the inability of indigenous firms to move from the informal to the formal sector, including access to land, finance, electricity, and phones. Firms in the formal sector also face challenges such as corruption, tax rates, and labor regulations. A final deterrent is the cost of registering a firm in the formal sector. It can take two months or longer to complete because of up to 17 different procedures that are administered.

Dr. Ramachandran has two suggestions for how to fix the low levels of indigenous participation in Africa’s economy. First, the investment climate needs to be improved. Networks need to be created. There also needs to be a decrease in the cost of registration as well as increased benefits to formalization. Secondly, there needs to be accountability for the governments, which may be giving preference to small, minority dominated firms because they believe they are not a challenge to political power. The ultimate goal should be to move towards a broad-based, well regulated private sector.