Published in Eastern Africa magazine, 20th August 2005

Formalising the business sector in Tanzania

Rigid and ungainly regulations is one explanation to the vast informal sector in Tanzania. More appropriate laws is, however, not the only solution. Structural reforms have to be followed by an improvement of the infrastructure if the business activity will be able to pick up in all parts of the country.

The Tanzanian reform programme to formalise the informal sector was launch last year, and before any reforms can be implemented the main problems - the extent of the informal sector, and the reasons why people chose to stay in the informal sector of the economy – had to be identified. The initial stage of the programme is now about to be concluded.

"We now have some ideas about the scope of the informal sector, and also why so many people decide to stay informal", says Ladislaus Salema, who is the co-ordinator of reform programme.

The study so far shows that around 70 per cent of the people in Tanzania belongs to the informal sector. In the rural areas, 70 per cent of all the businesses are informal. That means that the informal sector is equivalent to about half of the country´s GDP. An informal business is not registered by any authorities, which means, among other things, that the owner does not pay any tax. But it also means that the owner and the business do not have access to services within the formal sector of the economy, for instance the credit market. There are no registered assets that can be used as collateral when applying for a bank loan. That is one of the main reasons that small companies in Tanzania usually remain small. They cannot afford saving and since they are outside the formal sector they cannot borrow money from the bank.

The value of the informal assets in the big cities in Tanzania – mainly houses and plots – amount to $11-12 billions, according to the study. This is a figure of what some economists have named the dead capital in Tanzania. That the capital is dead means that it - since it is not registered - cannot be transformed into cash – cash that can be used for new investments.

The fact that many investments never are realized is hampering the overall production in the country and is also creating an income shortfall among many citizens. The formalisation programme was created to deal with this problem.

The main questions is then; why are owners of small businesses not interested in joining the formal sector of the economy?

"If you are supposed to register a company according to all existing rules, its takes up to one year", says Mr Salema.

"And if you are supposed to register a house according to all rules it can take up to eight years before you have the title deed in your hands", he adds.

Even though the actual reforms are yet to be decided it is obvious that many rules and regulations when it comes to register assets and businesses must be looked over. This also includes the costs of register a business. Because what the recent study also shows is that many small businesses, specially in the rural areas, sometimes actually share one business licence, and then sharing the costs.

Apart from the fact that many rules and regulations must be simplified, Mr Salema can identify other reasons for many businesses not joining the formal sector.

"Since many businessmen cannot se any big potential for their businesses they do not see any use for investments. They believe they will not benefit by going formal", he says.

Mr Salema means that the main questions must be; where is the market? Is the market in Tanzania big enough to utilize, if not all, but a big part of the country´s dead capital? Even if the reforms seem to be appropriate, they will probably do little good without, for instance, a strong improvement of the country´s infrastructure.

If a businessman is about to expand his business – with the help of borrowed money - by selling his products in other areas than his own, he must be able to transport the goods to that area, and that for a reasonable price. If not so, there is no point in investing and expanding.

"When decide the reforms, we can not act isolated or completely independently. We have to take other development issues into account", says Mr Salema.

Mr Salema points out that the reforms that will be suggested and implemented within this programme will probably, if they are supposed to be successful, only work together with other necessary reforms. This can be reforms initiated by the government or reforms initiated by the private sector. For instance, many banks in Tanzania, including some of the commercial banks, have already increased their lending to smaller businesses. And the government has introduced a official loan guarantee scheme. The development of the land reform must also be taken into account.

The current reform programme was initiated when the Peruvian economist Hernando de Soto – on the request by Tanzanian president Benjamin Mkapa - visited Tanzania and Dar es Salaam in 2003. de Soto´s institute based in Lima – Institute for Liberty and Democracy (ILD) – got the task to make a report describing how a project formalising the informal sector in Tanzania could look like. The report was completed in early 2004, and form the plan for the project - Property & Business Formalisation Programme - that started late last year.

The project consists of four stages; (1) Diagnosis – "identify the problems", (2) Reform design –"decide what to do", (3) Implementation of the reforms – "doing it", and (4) Capital formation and good governance – "make sure that the reforms actually make a difference". Stage one and two of the project will take between 2,5 and three years to complete, and since the first stage is almost completed, the reform design is soon to take off.

According to a study by ILD the impact of the reforms is estimated to be seen after three years after the implementations. The full impact is supposed to come after six years. If the reforms are 60 to 80 per cent successful, they would enhance Tanzania´s long run growth rate of per capita GDP between 0,8 and 1,5 percentage points per year.

"By the year 2015 we are hopefully about to see some results of implemented reforms"; says Mr Salema.