Workforce informality is an ongoing struggle for the government

Despite numerous government initiatives conceived over the years to tackle workforce informality in Peru, it remains a major problem that shows few signs of swift resolution. Although the data vary depending on the definitions of “informality”, about 65% of businesses were considered informal as of April 2014. This compares unfavourably to some of Peru’s poorer neighbours, such as Ecuador and the Dominican Republic.

Causes

To properly understand informality, Jose Luis Sarrio, a partner and head of the international business centre at Grant Thornton Peru, told OBG it is important to distinguish between “informal businesses and informal individuals”.

Of the 11m Peruvians regarded as informal workers due to not having access to legally mandated employee rights or not receiving the minimum wage, 2m are employed in formal companies. According to Macro-consult, a Peruvian consultancy firm, these figures mean that 70.9% of the economically active population was informally employed, be it in formal or informal businesses, in 2014, a decrease of 10 basis points compared to the previous year.

A study by Peru’s Central Bank concluded that high rates of informality were due to “a combination of poor public services, an oppressive level of bureaucracy and weak government capacity to implement and enforce policies”. These factors are aggravated by low levels of education and demographic pressures, the report said.

Carrots & Sticks

According to Sarrio, informality cannot be tackled directly. Rather, economic development, which in turn generates jobs, will ultimately reduce labour informality, with tax enforcement and education playing a supporting role. “The moment people become wealthy enough to want to buy a house, they will quickly discover it is in their interest to become part of the formal labour force,” Sarrio said. “Without that they will find it difficult to obtain any of the services that they need, let alone a mortgage.”

Sarrio went on to add that “incentives have a crucial role to play in bringing people into the tax system. Our present rate of income tax of 30% acts as a strong disincentive in this regard.” However, research by Yazan Al Karablieh of Harvard Kennedy School, found that “Peru maintains an internationally low tax burden and has maintained a relatively simple earned income tax over the past decade”. Al-Karablieh also notes that “the rise of labour informality from the early 1990s coincided with a simpler earned income tax schedule, showing a negative correlation between taxation and informality,” suggesting that tax incentives and less bureaucracy alone will not solve the problem.

Enforcement

This means that enforcement of tax laws has a role to play in the struggle to reduce informality, even though it is a challenging task. The main obstacle to trying to enforce the rules is a lack of capacity, according to Sarrio. “Imagine if all of a sudden the municipalities were to start cracking down on informal businesses – they would be inundated with permit applications that they would not be able to handle,” Sarrio told OBG, while recognising that it is a complex problem to address.

Entrepreneurial Spirit

However, there are those who see a silver lining to the problem. Alejandro Rabanal, head of equity research at Credicorp Capital, suggested to OBG that “up to a point, the prevalence of informality in the workforce has pushed Peruvians to become more entrepreneurial”.

Aldo Defilippi, executive director and CEO of the American Chamber of Commerce of Peru, agreed that Peruvians are ingenious and entrepreneurial by nature, but added that the question becomes how to transition these entrepreneurs into the formal sector, so their business ideas can be developed further and the benefits spread more widely. Indeed, the pool of informal talent in the country represents a great economic opportunity for Peru in a number of ways.

Peru’s informal labour force can be viewed as an untapped demographic resource that, over the medium to long term, will contribute to the country’s growth as these workers begin the process of formalising.