ENTREPRENEURSHIP IN THE INFORMAL SECTOR DURING TRANSITION: CAUSES, SPECIFIC FEATURES, SOCIO-ECONOMIC EFFECTS

A. Chepurenko,

J. Round

National Research University Higher School of Economics

Introduction

While there is a relative lack of discussion on the specifics of entrepreneur­ship in transitional economies there is a broad agreement that the level and forms of activity is lower than in more developed economies and that the sector's growth rate has been disappointing (see for example: [Thurik, 2009; Stam, Stel, 2009; Aidis et al., 2010; Mickiewicz, Estrin, 2011]).

The intensity and structure of entrepreneurial activity in transitional countries: GEM 2011 evidence

The initial hopes that the emergence of a market economy would see a rapid increase in entrepreneurial activity and enhance the possibilities for innovative new

ventures were not realized in most transitional countries [Mickiewicz, Estrin, 2011]. After a significant but short entrepreneurial boom at the start of the transition period in most post-socialist states the dynamics of entrepreneurship development declined. Some smaller Eastern European countries show a density of entrepreneurship com­parable with more mature European economics but most of the bigger CIS economies are characterized by very low levels of entrepreneurship and a very small portion of the entrepreneurial firms are really engaged in high-tech innovative ventures (for fur­ther discussion see [Obraztsova, Chepurenko, 2010]).

It is evident that the most sources of official statistics may hardly be used to make estimations of numerical data concerning the informal entrepreneurship. More­over, there are no reliable alternative sources which could enable any cross-country comparison of this sector. The most relevant and reliable source to compare entre­preneurial activity of physical persons across countries, Global Entrepreneurship Mo­nitor, exploring the entrepreneurial engagement of the adult population in several countries of the world since the late 1990ies, enables an access to the unique data­base to estimate the share of population engaged in any forms of entrepreneurial activity or quitting a business. Despite this it does not focus on questions of formality/ informality, basing on this data at least very general estimations of the total entre­preneurial activity, motivation structure and human and social capital assets of en­trepreneurs.

First, on the base of the GEM^[LXXVIII] data, it is possible to confirm that in most of the transitional countries the entrepreneurial engagement of adults is rather modera­

te or even low on each stage of entrepreneurial activity (Table 1). Meanwhile, some authors insist on the thesis that informal entrepreneurship in transitional countries may rely on the fact that many adults during the systemic transition were been pushed into entrepreneurship. This thesis finds support only for some of them (Bos­nia and Herzegovina, China), whereas in other transitional countries the necessity entrepreneurship in general does not exceed the average numbers for respective croups of countries.

Table 1. Entrepreneurial activity in 54 economies

by phase of economic development, 2011

Source: GEM 2011 Adult Population Survey.

Belonging to two different groups of countries, efficiency-driven and innova­tion-driven, most of them belong to those with the lowest level of entrepreneurial activity (TEA level, in terms of the Global Entrepreneurship Monitor - see Fig.

Note: GEM groups the participating economies into three levels: factor-driven, efficiency-driven, and innovation-driven. These are based on the World Economic Forum’s (WEF) Global Com­petitiveness Report, which identifies three phases of economic development based on GDP per capita and the share of exports comprising primary goods.

Fig. 1. Total early-stage entrepreneurial activity (TEA) in 54 economies, by phase of economic development, 2011

Source: GEM 2011 Adult Population Survey.

If we take the above GEM data for the transitional countries, we can conclude that in general:

• the level of early entrepreneurial activity is relatively low, below the aver­age (with a few exceptions);

• the level of perceived opportunities and perceived capabilities to start-up is as a rule lower, whilst the level of fear of failure - higher than in the respective group of established market economies;

• the share of necessity-driven entrepreneurs who might be the «natural» body of informal entrepreneurship - is hardly higher than among all countries be­longing to each respective group (efficiency or innovation driven).

Why are entrepreneurship levels so low and informality so high in transitional economies (the example of Russia)?

Another specific feature of entrepreneurial activity in transitional countries is the informal character not only of start-ups but even of many already well estab-

lished businesses (see [Williams, 2010; Williams, Round, 2010] for further discus­sion). Gimpelson and Zudina (2011) have shown that in Russia employment within informal economies is growing at a faster rate than economic grown and than the incremental dynamics of jobs in formal economic activity. They argue that most of such people operating informally are sole proprietors or self employed in different sectors. There are numerous reasons for choosing informal entrepreneurial activity according to the mainstream literature (see [Williams, 2005, 2008; Marcelli et al., 2010]). Firstly, a lack of resources and credibility pushes some entrepreneurs into the shadow economy where only informal activities are possible. Secondly, levels of state regulation and administrative burdens may lead to the same result. Thirdly, there are some «avoidable markets» where informal activity only is possible and fourthly, some freelance activities can be started only as a second job realized on informal manner. In some weaker transitional economies, there are some additional reasons which lead to the growing number of business deals done informally.

As the above discussions have shown almost all of the indicators on entrepre­neurship in Russia are worse than in other transition countries and rates of informality are very high. The WEF report places Russia's institutions, when related to com- petiveness, at 128^th in the world out of 142 countries. Within this one of the main issues is the lack of juridical security which impacts negatively on property rights [Nystrom, 2008; Acs et al., 2008]. As Aidis et. al. (2010, p. 21) state:

The strong protection of property rights plays a pivotal role in the institutional environment. This is a single dimension, which dominates all other institutional variables when we compress the data into a smaller number of dimensions using factor analysis...

Interviewees we asked in different Russian regions in 2007-2008 on entre­preneurship conditions bringing them to informality discussed how it is extremely hard to get credit to start, and/or expand, a business and there is little culture of lend­ing to nascent entrepreneurs. Further to this Russia suffers from an overly bureau­cratic system with regards to the regulation of enterprises, as one interviewee said:

I have never thought about getting a license because it is a very complicated bu­reaucratic process. I just do not have time and the nerve to stand in lines for days and weeks. It is amazing; if the state wants taxes why does it not organize things so that all the procedures to get a license go quickly and without bribes? I have the impression that if a person wants to pay taxes out of his/her off-the-books income in this country, they have to be obsessed by this idea and fight for their rights to do it with the state itself.

All in all, for the nascent entrepreneur there is little advantage in trying to be­come formal quickly given the paperwork and time involved. Exacerbating the amount of paperwork needed to start a business is the informal payments that are

often needed to be paid to state actors in order to get it completed. As an inter­viewee who is now operating wholly informally said:

I wanted to try and start a formal business but I was asked to pay so many bribes and in the end I just gave up. If there are so many payments to be made in just set­ting up a business how many would I have to pay in the future...

As cultures of informality become embedded then they begin to have a causal effect as people assume that they will have to make informal payments and there­fore do not even try to engage with formal state organisations [Round et al., 2010]. The fact that so many other areas of everyday life in Russia are infused with infor­mal practices also reinforces this cycle. As Williams and Round (2010) note only 10% of their respondents operate wholly in the formal sphere. Many interviewees discussed how even when in formal employment part of their salary is paid infor­mally («in an envelope») and thus a culture of informality across society is rein­forced. This is further entrenched by the coping practices many Russian households employ in the face of economic marginalisation with informal exchange, favours, informal secondary employment, inter-generational gifts among the many non-for- mal tactics employed. Therefore, a «circle of informality» can be seen to be in op­eration, which also includes subsistence economies in villages and small towns and households services provided informally, sees a significant amount of informal in­comes which may be realized in buying informally produced and distributed goods.

The low average income of Russian households also stymies formal entrepre­neurship development as it reduces the level of economic demand from the popula­tion and their ability to pay for services. As the costs of formalisation (through the paying for permits and informal payments) increases the transaction costs then it is in the interest of the entrepreneur to remain informal and at a small scale. There is no point in trying to compete with larger scale firms or with foreign firms because of this, which helps explain why so many Russian enterprises are small scale and involved in the service provision sector.

The lack of effective institutions and rent seeking officials, and the resulting culture of informality, also explains why the perceived opportunities and entrepre­neurial intentions are so low in Russia when compared to other transition countries and why the fear of failure is so high.

This is not to say that entrepreneurs do not wish to formalise their operations. The most common problem cited by interviewees was that acting informally made it almost impossible to obtain credit through the banking system. Thus they were often unable to fund expansion or to protect themselves during periods of low incomes. To expand, or to survive, interviewees had to turn to family or social networks but for

the vast majority there was a relatively small limit to what this form of fund raising could achieve. Furthermore, informality does not hide entrepreneurs totally from rent seeking officials and it makes them vulnerable to attack as because they do not pay tax, and are thus operating illegally, they thus do not have legal recourse if they are cheated or payments are not made. As one interviewee discussed:

I just wish things could be more secure. It is so tiring not knowing what the fu­ture will bring. If we could formalise like they do in the west it would make every­thing easier and we could concentrate on running the business rather than worrying about what tomorrow will bring.

Amongst interviewees who were considering starting an enterprise this con­tinual insecurity was the most commonly discussed reason why they were reticent to actually start.

Conclusion

The low levels of entrepreneurial activity in Russia, and the high levels of in­formality contained within the sector, are resulting from the character of socio­economic model and have significant implications for the wider society. As Che- purenko (2011) notes entrepreneurialism has positive impacts upon society as it brings dynamism, new approaches and innovations and helps develop societal norms (see also [Bahmani et al., 2012; Di Martino, 2012; Katic et al., 2011] for further discussion).

On a more practical level obviously informality means the Russian state re­ceives a lower tax base than it could otherwise expect. Hence, bribes increase the personal welfare of bureaucrats but diminish the external outcomes of the SME sector for the society as a whole. Moreover, operating informally also dramatically constrains the ability of enterprises to grow as they are unable to obtain credit and are worried about the behaviour of rent seeking officials. They do not provide addi­tional employment opportunities for others and there is little local, regional or na­tional expansion. Furthermore, a certain scale effect occurs: to establish a venture in the formal economy, you might possess over well functioning relations to decisions makers - if nit, you are enforced to start-up in the shadow and remain informally as much as possible. This stymies competition against foreign and large Russian firms which enables monopolistic growth within sectors, reducing competition, further increasing barriers to entry.

That is why - in parallel with recent measures aimed at increasing innovation and entrepreneurship, such as Skolkovo and establishing of development institu­tions, attention must be paid to smaller service based firms as well.

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