Intervention (Hidden)
The objective of the project is to understand the determinants of formality in Benin, where the majority of businesses are informal and owned by individual entrepreneurs.
Context:
OHADA member countries (Organisation pour l'Harmonisation en Afrique du Droit des Affaires) have adopted a revised General Commercial Law in December 2010, which came into force in May 2011. Among other provisions, the new law introduced the legal framework for the entreprenant status, a simplified legal regime for small entrepreneurs that aims at facilitating the migration of businesses operating in the informal sector into the formal sector. However, the law did not explicit how the entreprenant status would practically function, nor the specific combination of incentives that it would include, allowing instead each country to fill in the vacuum through ad-hoc secondary legislation. Benin, a member of OHADA, is currently implementing the legal and administrative regulation that will define the entreprenant status.
Details of the intervention:
The entreprenant status can be considered as a package of incentives to formalization that the Government offers to small business. The ongoing implementation of the entreprenant status in Cotonou offers the ideal conditions to study the impact of different packages of incentives on formalization decisions, the legal environment in which firms operate, and how businesses interact with public authorities. Also, it can show the impact of different firms and entrepreneur characteristics as determinants of formalization, and whether specific incentives carry any tangible benefits for the firm and its growth prospects.
The impact evaluation of the entreprenant status tests the three following packages of formalization incentives:
Package A of incentives includes the following components:
• Regulatory simplification: a streamlined business registration process, including a reduction in number of steps, time and cost to register;
• Provision of information on the new registration system: information on the new system is given in-person to business owners;
• Provision of tax information: information and clarification on the existing tax regimes applicable to the Entreprenants.
Package B of incentives includes the following components:
• Services and training: services include support to entrepreneurs in the formalization process and, for example, help in drafting financial statements and business plans; support in bookkeeping; training include basic accounting and business management, initiation to legal and tax obligations;
• Support with bank services: creation of a bank account (checking or saving) with a commercial bank.
Package C of incentives includes the following components:
• Provision of tax returns certification and tax mediation/counseling services: support on preparing and certifying the tax declarations; provision of safeguards against arbitrary practices from the tax administration through mediation services between Entreprenants and the tax authority.
Theory of change:
The key assumption of the entreprenant status is that it will encourage formalization by making business registration and operations simple, cheap and fast. Much of the literature has focused on easing business start-up regulations, and it has found that large improvements in the ease of start-up are associated with more companies registering. There is less evidence on the formalization of smaller enterprises. A reform in Mexico, which was implemented in some of the most populous and economically developed municipalities starting in 2002, reduced the number of days taken to start a business from 30.1 to 1.4 on average. Bruhn (2011) used data on individuals’ employment status from the Mexican Labor Market Survey (ENE) to show that this reform increased the number of registered business owners by 5 percent. However, recent information campaigns following simplification of registration requirements have resulted in very few informal firms registering.
At the same time, there may be incentives other than easing the regulations to register that could attract the informal sector into formality. For instance, the main drawback firms typically see from formalizing is the taxes they expect they will have to pay. In most countries, informal firms view tax revenues as minimally beneficial to themselves, their families or their community. They also worry about the risks of harassment from inspectors. To our knowledge, there is no empirical evidence of the effect of tax mediation/protection that would directly address these issues. These features of the entreprenant program will explicitly test this question of tax mediation/protection.
While formalization itself is an outcome of interest, this study will attempt to uncover the channels by which formalization may improve firm performance. First, bank financing is often hypothesized as one of the major channels through which formalization can improve firm performance, yet randomized experiments measuring formalization in Sri Lanka and Brazil have recorded no significant increase in the number of bank credits awarded to firms becoming formal. One possible reason is that newly formalized firms require more than just their formal certification, but also facilitation and access to banks. This access to credit is important as McKenzie and Woodruff (2008) demonstrate. Using evidence from Mexico, they show that relieving credit constraints leads to increased returns to capital by 20-30%, on average, and 70-79% among those firms that reported being financially constrained. Hence, offering firms much more hands-on support in accessing bank financing could make formalization much more attractive and beneficial to firms.
Second, formality may offer small firms the ability to pool risk, thus attracting more educated workers who engage in longer term relationships with the firm. This, in turn, makes training and capital acquisition more profitable. Additionally, formalization may incentivize businesses to invest in a fixed locale, permitting expansion of capital and employment. Fajnzylber et al. (2011) examine these channels in an evaluation of Brazil’s formalization program, SIMPLES. They find that the large increases observed in firm performance due to formality may indeed be driven by these factors. They find that formality increases firm employment by 40-50% and increases the probability of having a fixed location by a 30-50%, leading to large increases in revenues and profits. Similarly, in Viet Nam, firms that decided to formalize in the period 2007-2009 saw an increase in their profits and investments compared to similar firms that remained informal. McKenzie and Sakho (2010) find evidence in Bolivia that firms that become formal issue more tax receipts and have greater sales. De Mel et al. (2013) find that firms in Sri Lanka are more likely to advertise, while Bruhn and McKenzie (2013) highlight that the literature shows that formalizing may help firms to expand their customer base. These studies underline the fact that these and other important channels may exist by which firms interact with formalized status to attain higher performance.
In addition, formalization may have a gender dimension worth being explored, the evaluation aims at looking whether or the entreprenant program is more effective for women. In order to do so, the team will stratify the randomization by gender of the firm owner. In addition, the team will analyze whether the program can improve women empowerment.
Finally, one important limitation in the existing literature on both the effect of entry regulation on formalization, and the effect of formalization on performance, is its focus on evidence from Latin America and Southeast Asia. The impact evaluation of the entreprenant status in Benin will provide rigorous evidence on the impacts of formalization in an African context.