Gianinna Osorio is a real estate broker is Chile, and the founder of Inviertefeliz.cl. Her company offers free financial, real estate, and tax advice for real estate investment, generating over US$ 80,000 per month. Her motivation stems from her childhood, during which her family's lack of financial education led them to go bankrupt three times.  

These experiences inspired her to educate and guide others in financial education and real estate investment with the goal of empowering people to control their financial future. Initiatives like Gianinna’s can help provide support to informal entrepreneurs and firms and champion actions policymakers should take as well to support sustainable development. 

Informality vs Formality  

Informal firms are companies that are not registered and operate under the state’s radar. Although the informal sector exists in all economies, the highest rates of informality and informal new firm creation are in low-income and emerging markets such as Sub-Saharan Africa, Latin America, and South Asia, where they provide approximately between 60% and 90% of non-agricultural employment.  

Alongside the distinction between formal and informal firms, entrepreneurship can also be divided into that motivated by business opportunities, and that driven by necessity (when individuals create firms out of lack of attractive employment prospects).  

The dominant view of new firm creation has been focused on the concept of “dual economy,” in which there is a conflation of informality and necessity motivation, associated with low human/financial capital and productivity and formality and opportunity motivation, associated with positive benefits for growth and development. 

A new typology of firms  

We propose four instead of two categories of new firms. The first two are consistent with the standard ‘dual economy’ model, the latter two are not. 

• Type 1: informal-necessity new firms are created to make ends meet, by lower-income and educational-background individuals who face challenges entering the job market; these firms are low-productivity businesses. 
• Type 2: formal-opportunity new firms are created by higher-income/educated individuals and generate positive benefits for growth and development. 
• Type 3: informal-opportunity new firms are created by higher-income individuals who explore informality as a mechanism of testing their business ideas or learning about a business opportunity with a lower entry cost. 
• Type 4: formal-necessity new firms are created by higher-income individuals who find the formal path more attractive, even if their initial motivation is related to necessity. 

Using elements of the theory of occupational choice and paying particular attention to the individual's income at the time of the beginning of a new firm’s formation in Chile, we find that higher-income individuals often choose either formal-necessity or informal-opportunity paths to entrepreneurship, which is inconsistent with the ‘dual economy’ perspective. 

The extended taxonomy helps to explain changes to entrepreneurial activity over time. We observed that in response to a crisis (the COVID-19 pandemic), lower-income individuals will engage more in informal-necessity entrepreneurship. Parallel to that, the number of informal-opportunity new firms started by higher-income individuals will decline. 

Proposed guidelines to support informal entrepreneurs 

Though complex, due to its varied causes and forms, which also differ from country to country and even within nations, our research suggests guidelines for policy design and actions that policymakers can consider to address informality: 

Registration:  

Policymakers should make existing informal sector entrepreneurship, seen as a temporary phase of entrepreneurship, legal and attractive rather than just allowing it. This can be achieved by removing initial requirements associated with formal registration. The need to register could be gradually imposed above certain revenue thresholds.  

It would also be beneficial for local communities to have a greater role in the registration and taxation of new and small businesses. For instance, if an ethnic minority group in a specific area is provided with the necessary authority to define conditions for registration, then the income generated from it should remain within that community.  

Elimination of excessive regulations and bureaucratic requirements also helps. Policymakers need to consider how much trust people have in government administration at its different levels (i.e., local, central) because this will have a significant impact on incentivising people to formalise their activities, particularly because local communities are often trusted more than the central government. The latter is often seen as remote, the trust is missing, and the regulations imposed centrally are less likely to be followed. 

Improve tax systems design:  

Authorities should consider the unintended consequences that may encourage individuals and companies to remain in the informal sector. Simple tax codes with low rates and a low payroll tax can help. It is also critical to establish supportive social protection systems that include progressive income taxes and protection for those in the most vulnerable positions to address issues of distribution, and at the same time create incentives to support oneself through entrepreneurship so that the entitlements are not lost at low levels of entrepreneurial income and are reduced gradually as income raises.  

Allowing tax breaks until sometime after registration would also help, and ensuring they are individual or household specific limits that could mitigate opportunism such as repeated registration. However, with the emphasis on the role of the informal sector in innovation, the latter will be supported through experimentation if an initial informal stage is allowed. 

Improve equality and  inclusion in structural policies: 

To support sustainable development, various structural policies require investment in education equality, financial inclusion, labour market and technology policies that increase returns, incentives, and decrease costs. These can include: 

• Improving education outcomes through reforms that prioritise equal access and encourage the population to complete at least technical and vocational training. 

• Improving financial inclusion through reforms that enhance minorities' access to formal financial services, which can reduce informality and increase growth expectations for firms and entrepreneurs. 

• Improving the labour market inclusion through reforms that simplify and make it easier for informal workers to enter the formal job sector, creating a more flexible and inclusive workforce. 

• Improving technological inclusion by using digital platforms and open innovation, including government-to-person mobile transfers, which empower minorities financially, help new enterprises grow, and may generate synergies with financial inclusion. 

• Improving crisis management policy design. As the experience of the COVID-19 pandemic demonstrated, a rapid yet well-designed response to crisis is important for businesses and for creating incentives to stay formal. We need planning to anticipate potential new crises and design response. 

Change through practice 

However, the government need not be the only agent of change. There is an important role for socially oriented entrepreneurs, such as Gianinna Osorio, who engage in critical knowledge transfers shown in current focus on making information more accessible which can help decentralise financial education. Efforts like Gianinna’s as critical for enhancing chances for survival, scaling-up, and formalisation of entrepreneurs with disadvantageous backgrounds. 

A gradual shift towards increased formality or a reduction in informality of new firms over time will contribute to sustainable, dynamic, and competitive growth at both new business and country levels. Consequently, this shift also fosters inclusion and equality. Both the government, private actors, and entrepreneurs with social motivation can contribute to this outcome.  

This article by Professor Saul Estrin, Emeritus Professor of Management Economics and Strategy at the London School of Economics, Dr Maribel Guerrero, Associate Professor of Public Policy and Management at the School of Public Affairs and Global Center for Technology Transfer at Arizona State University, and Professor Tomasz Mickiewicz, Professor of Economics at Aston University, is based on their new research on opportunities for informal entrepreneurs in emerging economies. 

Open access article: https://doi.org/10.1016/j.jbusvent.2024.106404  

Estrin, S., Guerrero, M., & Mickiewicz, T. (2024). A framework for investigating new firm entry: The (limited) overlap between informal-formal and necessity-opportunity entrepreneurship. Journal of Business Venturing, 39(4), 106404.