In 2003, Thabo Mbeki – then President of South Africa – described the South African economy as a two-story house. The top floor was quite plush, with all the furnishings neatly packed together. He referred to this as the modern, diversified economy in South Africa. However, below this level was an informal economy, where the poor with little or no skills were trapped in poverty.
Mbeki’s analogy went even further: there were no connecting stairs between the two floors. In fact, South Africa had two economies and there was no bridge between them.
What Mbeki described is a common problem in developing countries, including South Africa’s neighbor Zimbabwe. My colleague Baldwin Guchu and I recently conducted an investigation into an initiative in Zimbabwe that is trying to address the problem. In the paper we reviewed, we examined the role that intermediaries play in linking the formal and informal economy in the country. South Africa can learn from this.
Since 1994, South Africa has been building on the existing two-storey infrastructure without paying much attention to stairs. At least not one that’s wide or sturdy enough to encourage upward movement. This poses a serious development problem – one shared by many developing countries.
Academic research typically refers to this as a function of the dualism and lack of institutional links between these dual economies: although institutions set the “rules of the game” that govern economic activity in each of these economies, the institutions do not bridge the two distinct economies and so coexist them, but isolated.
How often do we hear the refrain that big companies don’t do business with small companies?
The result of this missing link is that the two economies struggle to connect, leading to inefficiencies and significant missed opportunities. Worse still, it perpetuates social and economic divisions and deepens inequality. We see this manifesto in South Africa in different ways.
South Africa has deep and liquid financial markets, along with a highly functioning and well-regulated banking sector, meaning our top-tier financial system is able to compete well with all of the world’s leading economies. Access to capital should therefore be universally available.
But it is not. Many small businesses do not meet the criteria for top-floor financing. In developed economies, small businesses have a number of alternatives to financing from banks or other capital markets, including secured and unsecured options.
How can this be fixed? The assertion that “it’s the government’s job” ignores other actors who have the capacity to play a more innovative facilitating role.
If South Africa’s two-tier economy is strong, Zimbabwe’s is austere. His house is pyramid shaped. Nevertheless, there are attempts to connect the different levels with each other. In our research, we investigated what these are.
The role of mediators
Zimbabwe is known for its weak and extractive political and economic institutions. The World Bank estimates that the informal economy accounts for about 60% of the overall economy; around 90% of those considered “employed” work in the informal economy.
This is particularly true in agriculture, where the combined legacy of colonialism and, more recently, land grabbing has left a divide between large commercial farmers and small, often subsistence, farmers.
These smaller agricultural producers work together in their villages through a system of mutual trust, but this practice does not extend beyond the villages. Tight statutory contracts are required to sell to the larger players in the retail industry. In addition, small farmers need some level of financing to ensure access to machinery and a sustainable supply of raw materials needed to grow, harvest and store their crops.
This is not possible without collateral to guarantee a loan or purchase contracts from retailers. The result is that they are caught in a vicious circle – they cannot borrow money to produce, nor can they produce to borrow money.
This is where an organization like the private, for-profit company Palladium can step in. Your approach is collaborative. In this case, it supported a donor-funded project that acts as a bridge between the formal and informal economies, connecting small farmers to formal markets. In other words, the staircase between the two floors.
Palladium acts as an intermediary in several ways. It facilitates contract farming by connecting input suppliers with small farmers who then agree to sell the produce back to them at a pre-agreed future price. This addresses input funding and provides a guaranteed market for the farmers’ output.
It is also building partnerships with the private sector to enable mobile purchasing systems. This frees farmers from finding a market and ensures them a fair price; moreover, it relieves them from the problem of storage and packaging.
As part of a consignment stock initiative, the intermediary also maintains an electronic transaction history that farmers can use to access credit in the future, providing records and information that would otherwise be missing.
solutions
All of these interventions are better served by intermediaries than by government bureaucracy. This is particularly true where government institutional capacity is weak and corruption is widespread.
Governments with little or no entrepreneurial thinking fail because they see no gap that they can sustainably fill. What governments can do is enable policies that support these intermediaries to function effectively, recognizing that traditional boundaries between the public and private sectors are increasingly blurring and hybrid partnerships offer the potential for innovative solutions.
For their part, large corporations need to recognize that maintaining the status quo of dual economies delegitimizes markets and causes opportunities to be lost.
The question for the facilitators is to envision ways in which bridging support can extend beyond project initiatives. These projects are time-bound, with limited budgets. If such interventions are not done with longevity in mind, they can create dependencies instead of resolving them. Therefore, longer-term, more sustainable solutions need to be devised to bring the formal and informal economy closer together. And also to ensure permanent integration.
Without this kind of lateral thinking, countries like Zimbabwe and South Africa will continue to have two-story houses with no stairs, leaving the majority of citizens stuck on the ground floor looking up. Such structural inequality is unsustainable.
Baldwin Guchu is co-author of this article. He has a background in financial management. His work focuses on the link between institutions and financial markets in developing regions.
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