The formal sector now employs just 9.6-million people. The last time it employed this few was 2010. The formal sector is in trouble.
The informal sector has done rather better. In the Covid-19 era, both formal and informal sectors experienced a sharp decline in employment when lockdowns started in March 2020, but then there was a quick recovery in the second half. The problem is that recovery was short-lived for the formal sector, which saw employment slump throughout 2021, to levels below the lockdown. In contrast, the informal sector has sustained its recovery trend.
It suggests that formal businesses are struggling to resume operations with previous employment levels, but informal businesses are not. Why the difference? Is it because formal businesses are being constrained by Covid-19 regulations such as social distancing from resuming full operations and therefore staffing levels?
That is part of it. Generally, the constraints imposed on businesses throughout the pandemic have been haphazard and unnecessarily damaging. But I fear that this is a symptom of a deeper problem — a complete lack of political support for the formal sector.
There has been an intense, continuous ratcheting up of regulations that formal businesses face. It is complex and expensive to run one. The informal sector faces fewer such headaches, and entrepreneurs can pursue profits relatively unfettered. It is also helped by the growth in social grants that tend to find their way more to informal and rural economies.
Formal employment has been struggling to grow for more than a decade — the Covid-19 crisis has just worsened it. This is reason for alarm, not just about unemployment, but the wider impact of a troubled formal sector.
The other way to see the decline of the formal sector is in tax receipts. In 2020, 704,000 companies were assessed. That is down from 980,000 in 2017. The tax raised has obviously fallen too — from R212bn to R125bn. That reflects the general decline in numbers as well as profitability of formal enterprises. Overall revenue collection has become much more reliant on VAT and personal income tax.
The annual financial statistics released by Stats SA in December showed that profits have been falling — dramatically in 2020, but generally on a downward trend for more than a decade. There are many reasons for that, most obviously the dramatic rise in energy costs. Companies now spend twice as much as they did 10 years ago on electricity, the biggest contributor to the erosion in profitability. Anecdotally, companies are also spending much more on accessing basic services such as water and security.
The divergence in performance of the formal and informal sector recalls Thabo Mbeki’s notion of two economies that was much discussed in 2003. Then he said the first economy “is modern, produces the bulk of our country’s wealth and is integrated within the global economy”. The second economy “is characterised by underdevelopment, contributes little to the GDP, contains a big percentage of our population”.
If we look at things through Mbeki’s prism, it appears that the first economy is facing strong headwinds, while the second economy is in rather better shape. While it has long been a development objective to reduce the chasm between the two economies by promoting cross-linkages, I don’t think any serious policy thinker in SA sees the shrinking of the formal sector as a good thing.
We talk far less about the deformalisation of the economy compared with other themes such as its deindustrialisation. The formal sector — with its banks, mines, manufacturers, retailers and so on — carries the weight of employment and tax generation. If it is in trouble, much follows from that, particularly the effort to create high-quality jobs.
The trouble is that the formal sector has few political champions. You might expect the department of trade & industry to be focused on creating a positive environment for both formal and informal sectors, but instead it is a fountain of business-unfriendly regulations.
The latest are proposed amendments to the Companies Act including requirements for lots of additional salaries disclosures. It has also made the competition authorities into a vehicle to pursue all kinds of social objectives, rather than strictly the competitiveness and openness of the economy to new entrants.
The National Treasury through its wider economic policy and financial sector oversight does obviously consider the impact of various measures that could stimulate formal business activity. Its effort to consolidate various tax breaks available to businesses into a simplified one percentage point cut in the corporate income tax rate to 27% is a good example. It is meant to start in April, but is facing pushback.
It will be a good test of whether the rest of government is able to take seriously the need to support the formal sector, or whether the proposed cut will disappear amid calls for higher social spending.
The formal sector needs a political champion now. The first target should be Covid-19 regulations that continue to impose expensive and unnecessary burdens on formal businesses. Delivering the promised tax cut would also help. But then the painstaking business of building a policy environment that would reduce the costs of operating a formal business must begin.
That is the sustainable way to improve employment and wider compliance in the economy.
• Theobald is chair of research-led consulting house Intellidex. This article first appeared in Business Day.