Financial inclusion, informality and sustainable development

Financial inclusion has been presented in some policy and governments blueprints as well as important development documents as an instrument of poverty extermination in the so-called poor countries and the developing world.

The shared dictum across the development sector is that financial inclusion guarantees to enhance poor families, especially those domiciled in the informal economy, ability to minimise financial shocks, undertake human capital investments in health and education and, or engage in modest asset accumulation in order to take advantage of promising investment opportunities in their economies.

The Sustainable Development Goals (SDGs) provide a framework for addressing poverty, hunger, gender inequality, and climate change, which are some of the world’s most critical concerns.

Because Africa faces such formidable development obstacles, these goals are particularly significant there.

Significant investments in infrastructure, education, healthcare, and job creation are needed to accomplish the SDGs in Africa, as well as targeted initiatives to support the most vulnerable people.

However, the success of these actions largely relies on having a sound financial structure.

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Just as a strong foundation provides support for structures, a functioning financial system acts as the backbone by channelling resources and facilitating efficient and transparent allocation of the same.

However, according to numerous studies, the financial sectors in most sub-Saharan African (SSA) countries have been found to be disinclined to or unable to serve the poorest segments of the populations and this is even more pronounced within the informal economy.

The term “informal economy” is found in the literature under alternative though not necessarily equivalent names, such as shadow economy, underground economy, hidden economy, black economy, cash economy, among others.

 Feige (1979, 1996), defines four types of “underground economy”: illegal, unreported, unrecorded and informal; in particular, the informal economy comprises economic activities that circumvent costs and are excluded from the benefits and rights incorporated in laws and administrative rules covering property relationships, commercial licensing, labour contracts, torts, financial credit and social systems.

Be that as it may, one key message is that financial inclusion alone may not provide the poorest segments of African populations with the skills, services and competences they need to find pathways out of poverty and deprivation.

For this reason, inclusive finance must endeavour to strengthen individuals' control over their lived situations and reinforce their beliefs in their personal efficacy and effectiveness to pull them out of poverty.

The existence of informal activities can either promote or reduce financial inclusion depending with where one is reasoning from.

The informal economy represents a potential market for some financial institutions, because in many developing countries they can offer financial products to informal workers to finance their informal interventions, for example a loan to buy a car or a motorcycle to provide informal transportation services, in this case, a bigger informal market will lead to an increase in financial services.

This relationship is supported by Lahura (2016) who finds evidence that 1.8 million informal workers in Peru that have access to credit in the financial system.

More informality can also reduce financial inclusion because part of the financial resources will be used to check whether entrepreneurs are involved in informal activities.

Most empirical studies on informality have focused on identifying key determinants and/or predictors of informality.

 A number of factors have been evaluated such as tax and regulation burden, quality of institutions and government effectiveness, entrepreneur’s demographic and socioeconomic characteristics, industry and firm’s characteristics, macroeconomic variables; financial indicators, among others.

An increase in financial inclusion can reduce informality through direct and indirect channels.

On the one hand, the productivity gains associated to the access and use of financial services can stimulate informal firms to become more formal in order to exploit those benefits more proficiently and in line with the dictates of professionalism.

According to the Organization for Economic Cooperation and Development (OECD 2019), small enterprises can increase their productivity if they have access to financial services, which may entail an incentive to formalise.

According to Jacolin et al. (2019), the use of mobile financial services (MFS) such as mobile money, mobile credit and savings can reduce the informal sector by improving the access to credit and reducing the demand for cash that is moving from cash to digital payments promotes productivity and profitability by reducing operational costs and making commercial transactions more secure, fluid and cheaper.

However, evidence provided analyzed by La Porta and Shleifer (2014), suggests that informal firms barely make a transition to formality, even when they are encouraged or are offered to be subsidised.

On average, over 91% of registered firms started out as registered. Furthermore, informal firms seem to exist almost disconnected from the formal side of the economy: only 2% of informal firms sell their output to large firms.

 By making financial services more widely available and affordable, fintech contributes significantly to alleviating poverty, advancing sustainable agriculture and food security, expanding access to healthcare, advancing gender equality, and facilitating the use of clean energy across Africa.

Consequently, a synergy between financial inclusion and sustainable development is needed.

The synergy should be based on sustainability principles. This will require polices that integrate financial inclusion into the sustainable development agenda.

Regarding the informal sector, there is need to ensure a formidable and organised movement in the informal economy that is ready to not only challenge the status call but work, through research and advocacy, towards the changing of the laws that govern the sector.

Given the link between financial inclusion and development, governments should keep pushing for more access to and use of financial services.

 Prioritising financial services does not take away resources from other priorities set through the SDGs.

In fact, the evidence gathered to date by various development institutions builds a strong case that financial inclusion helps create the conditions that bring many of the SDGs within reach.

Granting access to basic formal financial services contributes to greater sustainable development by ensuring that access to finance is guaranteed in a sustainable way, and basic financial services are provided in a sustainable way and based on sustainability principles in order to yield lasting impact for sustainable development.

This approach links financial inclusion to sustainable development through the adoption of sustainability principles in offering basic financial services to banked adults including those that are in the informal economy.

• Samuel Wadzai is an informal economy expert and Vendors Initiative for Social and Economic Transformation   executive director
• These weekly articles are coordinated by Lovemore Kadenge, an independent consultant, managing consultant of Zawale Consultants (Private) Limited, past president of the Zimbabwe Economics Society and past president of the Chartered Governance and Accountancy Institute in Zimbabwe. Email- kadenge.zes@gmail.com or Mobile No. +263 772 382 852