Informality reduces GDP growth


By Cíntia Cardoso (Folha de S. Paulo, 22/08/2004)

More than reducing the State's tax collection potential, the expansion of the informal economy of the Brazilian economy jeopardizes the growth of the GDP (Gross Domestic Product).

"The process of expanding the informal sector is dredging up Brazil's growth potential," says Diana Farrell, economist at the McKinsey Global Institute, a research arm of the American consulting firm McKinsey.

The institute says that the Brazilian economy could show growth rates of GDP per capita around 7% per year. But, with the current level of informality resulting, says the economist, Brazil will hardly reach this rate.

Data recently released by the company show that the informal market represents almost 50% of the Brazilian GDP. Among developing countries, this market represents 40% of the national product of these economies. Among rich countries, the rate drops to 17% of GNP (Gross National Product), but is still considered high by the American economist.

To solve the problem in Brazil, evaluates Farrell, there is no short-term solution. More auditors for companies, reduced tax burden and reduced bureaucracy for the creation - and extinction - of companies are on the list of suggestions.
Next, the interview granted to Folha by telephone.

Folha - How can informality compromise a country's GDP growth?

Diana Farrell - Most people think that informality only limits the volume of tax revenue from the state, but it causes other problems. The expansion of informal businesses creates a network of suppliers and consumers who are also informal. This perpetuates the informality chain. This situation creates what I call the “low productivity trap”. People and companies that are informal, and therefore are in a position of lower productivity, tend not to be able to get out of this “gray area” of the economy. Companies that are legal also suffer because they have to face informal ones, which manage to sell at more competitive prices - and end up taking advantage. This further discourages the formal market, which is not motivated to invest and seek new technologies. As a result, the country also loses competitiveness in the foreign market. Anyway, the consumer loses, the economy loses. The process of expanding the informal sector is draining Brazil's growth potential.

Folha - According to your report, the trend is for the informal market to grow in Brazil. What are the obstacles to the legalization of companies that are informal?

Farrell - Brazil has a very high level of taxes. If we think about the stage of development that Brazil has today, this burden is not compatible. The coefficient between the tax burden and GDP in countries like Mexico and the United States is approximately 7%. In Brazil, it exceeds 30%. When we take an economy at this level of development and place this tax burden on it, it will certainly harm it. Another point is that there is still a precarious inspection to control the performance of companies. In Brazil, there is not an adequate number of employees, auditors, nor is there an adequate degree of technical knowledge. The punishments for companies that break the law, that defraud, are very mild. Another point is that informality is seen more as a social issue. Many think that informality helps to take the pressure off unemployment rates. This is a fallacy. High degrees of informality are detrimental to everyone. Dealing with all of these points is essential to reduce informality and grow the economy.

Folha - Is the expansion of informality a global trend or a Brazilian peculiarity?

Farrell - It is not an exclusive feature of Brazil. Countries like Portugal and Turkey, in other developing and developed countries, see levels of informality ranging from 20% to 80% - the latter index occurs in certain countries in Africa. Even in India, the level of informality is also high. This is not a Brazilian peculiarity. Brazil, Thailand and Turkey have similar levels of informality.

Folha - What would be an acceptable level of informality in Brazil?

Farrell - I will not say what the appropriate level would be, as there is no way to calculate it, but this [about 50% of GDP] is certainly not.