Regulation and the Informal Economy: Microenterprises in Chile, Ecuador, and Jamaica 9781685857950

Table of contents :
Contents
Part 1. A Comparative View of Regulations and Informality
Part 2. Microenterprises and the Informal Sector in the Santiago Metropolitan Area
Part 3. The Operation of Small Enterprises and the Institutional Framework in Ecuador
Part 4. Out of the Shadows: The Institutional Framework and Small-Scale Manufacturing Enterprises in Jamaica
Bibliography
Index
About the Book and Editors

Citation preview

REGULATION AND THE

INFORMAL ECONOMY

REGULATION AND THE

INFORMAL ECONOMY Microenterprises in Chile, Ecuador, and Jamaica

edited by

Víctor E. Tokman Emilio Klein

LYN N E RIENNER PUBLISHERS

B O U L D E R . L O N D O N

The designations employed in International Labour Office (ILO) publications, which are in conformity with United Nations practice, and the presentation of material therein do not imply the expression of any opinion whatsoever on the part of the ILO concerning the legal status of any country, area, or territory, or of its authorities, or concerning the delimitation of its frontiers. The responsibility for opinions expressed in studies and other contributions rests solely with their authors, and publication does not constitute an endorsement by the ILO of the opinions expressed in them. Reference to names of firms and commercial products and processes does not imply their endorsement by the ILO, and any failure to mention a particular firm, commercial product, or process is not a sign of disapproval.

Published in the United States of America in 1996 by Lynne Rienner Publishers, Inc. 1800 30th Street, Boulder, Colorado 80301 and in the United Kingdom by Lynne Rienner Publishers, Inc. 3 Henrietta Street, Covent Garden, London WC2E 8LU © 1996 by International Labour Organisation. All rights reserved Library of Congress Cataloging-in-Publication Data Regulation and the informal economy : microenterprises in Chile, Ecuador, and Jamaica / edited by Victor E. Tokman, Emilio Klein. Includes bibliographical references and index. ISBN 1-55587-608-0 1. Small business—Chile. 2. Small business—Law and legislation— Chile. 3. Small business—Ecuador. 4. Small business—Law and legislation—Ecuador. 5. Small business—Jamaica. I. Tokman, Victor E. II. Klein, Emilio. HD2346.C53R44 1995 338.6'42—dc20 95-33096 CIP British Cataloguing in Publication Data A Cataloguing in Publication record for this book is available from the British Library.

Printed and bound in the United States of America The paper used in this publication meets the requirements (So) of the American National Standard for Permanence of Paper for Printed Library Materials Z39.48-1984. 5

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1

Contents

Part 1 A Comparative View of Regulations and Informality Emilio Klein and Victor E. Tokman 1 2 3 4 5

Introduction The Survey Methodology Characteristics of the Firms The Legal Framework for Small Businesses in Chile, Ecuador, and Jamaica Compliance with Regulations Regulations: Causes and Effects

1 7 13 27 35 49

Part 2 Microenterprises and the Informal Sector in the Santiago Metropolitan Area Guillermo Wormald and Jorge Rozas 6 7 8 9

Introduction Profile of the Microenterprises Compliance with Regulations Causes and Effects of Regulatory Compliance Conclusions

61 63 79 91 101

Part 3 The Operation of Small Enterprises and the Institutional Framework in Ecuador Roberto Roggiero, Gustavo Rodriguez, Claude de Miras, and Pablo Andrade 10 11 12 13 14

Introduction The Legal Framework for the Operation of Small Enterprises The Labor Market The Market for Goods and Services Operating Features of the Microenterprises Regulations V

107 111 119 127 133 139

CONTENTS

VI

15 16

Support for the Microenterprises: Guild Associations and Bookkeeping Conclusions

Part 4

17 18 19 20

147 151

Out of the Shadows: The Institutional Framework and Small-Scale Manufacturing Enterprises in Jamaica Patricia Anderson

Introduction The Legal and Regulatory Framework for Small Businesses Operating Features of Small Manufacturing Enterprises Formalization and the Observance of Regulations The Outlook for the Small-Scale Manufacturing Sector

Bibliography Index About the Book and Editors

161 165 171 183 199 203 207 211

REGULATION AND THE

INFORMAL ECONOMY

PART 1 A Comparative View of Regulations and Informality Emilio Klein & Victor E. Tokman

Introduction to Part 1: The Informal Sector from an Institutional Perspective During the second half of the last decade, regulations became for several scholars the key to understanding the informal economy and to formulating policies related to it. Feige (1990), for example, finds that the relation of the informal sector with the regulatory framework characterizes "the new institutional approach to economic development." Two main lines can be distinguished within this approach. The first is based on the observation that the informal sector operates beyond the law because of inadequate legislation and inefficient bureaucracy. Regulations and government are identified as the main barrier to informal sector development (De Soto, 1986). A second interpretation also identifies operation outside of regulation as a main characteristic of informality, but this is seen as the result of the need for decentralized production and labor processes. According to this line of analysis, the search for flexibility and the need to diminish labor costs leads firms to bypass costly and rigid regulations. Internally the decentralization of production—made possible by new technologies—provides a functional response to the need to increase profit margins by diminishing or avoiding trade union power and by allowing the transfer of the cost of demand fluctuations outside the firm. Informality is thus related to the organization of production (Portes, Castells, and Benton, 1989). In Beyond Regulation: The Informal Economy in Latin America (Tokman, 1992), we explored the validity of the conceptual identification of informality and illegality and examined the impact of the regulatory framework with regard to firms' both becoming legal and operating within the legal framework. Four main conclusions were reached. Part 1 was prepared with the statistical cooperation of Christian Herrera.

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KLEIN & TOKMAN

First, the informal sector operates in a realm between "the underground" and legality, allowing the informal producer to obtain access to what she or he evaluates as important while minimizing the risks associated with illegality. Second, although some regulations could hamper the development of the informal sector, they nevertheless are justified by concerns for the good of the community. Third, a particularly sensitive issue is the application of labor regulations, which was found to be a crucial factor in determining the financial viability of an informal enterprise. Observance of some labor regulations tends to increase with the size of the microenterprise, but even the larger informal units see the need for social security affiliation as a major obstacle to economic survival. The policy issue is whether two-tiered labor legislation should be adopted, to which the International Labour Organisation (ILO) (1991) objects, or authorities should accept some degree of noncompliance. The latter has been de facto the route followed in most cases. A fourth conclusion was that the situation differs from country to country. In Bolivia and Chile, for example, the financial and time costs of meeting regulations are not high; in Guatemala and Mexico, both are significant. This disparity is indeed related to the adequacy of legislation and efficiency of the bureaucracy in each case, but these in turn depend on several factors that affect not only informal enterprises but also the country as a whole. History, cultural characteristics, and political and administrative organization seem to play important roles. Beyond Regulation raised many additional issues that need to be clarified. One of these is the definition of informality, an elusive issue that has confused the analysis of the informal sector and has been the subject of numerous studies (see, for instance, Tokman, 1978a, 1990; and Lubell, 1991). One type of definition refers to the regulatory framework and defines as informal all those activities that operate without conformity to that framework. The other type, which we find more useful from an analytical perspective, is based on economic criteria—mainly the absence of modern technology or the lack of physical or human capital. Although these criteria are difficult to apply, empirical studies about the informal sector traditionally have adopted as proxy a combination of occupational categories (selfemployed, no university education, unremunerated family workers) with size of establishment (microenterprises with fewer than five employees). The association of occupational category and size has proven to be a good indicator of level of technology, capacity of accumulation, productivity, and income effects. It is the approach followed in our previous works, and the one adopted in this book. In this study, however, the combination of the size criterion and that of physical and/or human capital was applied implicitly by selecting only microenterprises in specific sectors that did not include capital-intensive activities. Legal informality was not included in the definition, but was adopted as an outcome indicator. To allow for international comparisons the

REGULATIONS AND INFORMALITY

3

same sectors were covered in all countries: textiles, metalworking, woodworking, restaurants, and mechanical repairs. As only microenterprises were included, without considering independent workers, a higher degree of compliance with regulations was expected. Even so, as in our previous research, the most common cases were found in the gray area of being neither entirely illegal nor completely legal. If anything, the same methodology applied to the whole of the informal sector should show a higher degree of illegality, but it should be noted that in most countries legal requirements are not compulsory for independent workers. The objective of our research was to explore further some of the previous findings, and mainly to better understand why some informal units are more able than others to observe regulations and whether country characteristics significantly affect the situation. We also wanted to provide additional information about the effect of regulations on the growth of informal units and to widen the analysis beyond the regulatory framework to include the institutional environment (i.e., access to markets and financial resources). Our objectives coincided with those of a worldwide project launched by the Development Centre of the Organisation for Economic Cooperation and Development (OECD), which covers seven countries: Algeria, Tunisia, Niger, Swaziland, Thailand, Ecuador, and Jamaica (Morrisson, SolignacLecomte, and Oudin, 1994). We agreed to study Ecuador and Jamaica; Chile is also included in this book on the basis of a similar research project. The countries in our study were selected to provide diverse regulatory and institutional environments for comparison. Ecuador is a small IndianSpanish country with marked regional differences and a tradition of manual and handicraft work. By contrast, Jamaica is a very small Afro-British country, where tourism, trade, and services predominate. Chile was added to incorporate a mid-size country that, although it shares some of the historical background of Ecuador, constitutes a case of strong and efficient public administration. This is clearly illustrated, for example, by the number of days that the process of business registration takes, which is one-fourth the time involved in Ecuador. The financial costs to become legal are also a fraction of those in Ecuador, ranging from one-half for commerce to onetwentieth for industry (Tokman, 1992). These different historical and political settings result in a different system of regulations, evidenced in the number and complexity of laws and administrative procedures as well as in their degree of compliance. Ecuador, following the prevailing institutional tradition of Latin America, has a complex system of regulations as a result of numerous general rules plus special regimes to protect particular groups, which in turn require the administrative involvement of several governmental units. Jamaica, given its British influence in the law as well as in the structure of the public administration, has a simpler set of general regulations. Chile represents an intermediate degree of regulatory complexity.

4

KLEIN & TOKMAN

One would then expect that regulations are more easily enforced in Jamaica than in Chile or Ecuador. However, the degree of compliance according to size, sector, or location within each country cannot be anticipated a priori because it also relates to internal regulatory characteristics. In particular, government efficiency and fiscal discipline affect enforceability. One could also hypothesize the effect of these different country situations on informal growth. If promotional regimes are well conceived and effectively implemented, it should follow that Ecuadorean regulatory environments would be more conducive to informal growth than those prevailing in Chile or Jamaica. On the contrary, if promotional regimes are illdesigned and difficult to apply, the latter regulatory environments can prove to be better for growth promotion. The size and structure of the informal sector in the selected countries also varies. If the informal sector is measured as self-employment plus unremunerated family workers and domestic services, Jamaica and Ecuador register around 40 and 35 percent of their nonagricultural employment in that sector, whereas in Chile, the share is below 30 percent. Compared to Latin America as a whole, Ecuador is close to the average, Jamaica is above, and Chile below the average. If microenterprises are added, a factor that can be analyzed due to data availability in the two Latin American countries, informal employment accounts for half of nonagricultural employment in both cases. These issues will be examined here, on the basis of three surveys of small and microenterprises undertaken in Chile, Ecuador, and Jamaica. The study in Ecuador was done by Roberto Roggiero, Gustavo Rodriguez, Claude de Miras, and Pablo Andrade of the Centro de Investigación de los Movimientos Sociales del Ecuador (CEDIME). In Jamaica, the Statistical Institute selected the sample, carried out the fieldwork, and produced the data. The Jamaican report included here was written by Patricia Anderson of the University of the West Indies. For the Chile study, the research was conducted by Guillermo Wormald and Jorge Rozas of the Dirección de Estudios Sociológicos, Pontificia Universidad Católica de Chile, on behalf of the Ministerio de Planificación and under the direction of Oscar Mac-Clure, with the collaboration of Hilda Chiang and Deborah Ferrada. These studies are included as Parts 2, 3, and 4 of this book. We wish to acknowledge our appreciation for the technical and financial contribution of the Development Center of the OECD, which made it possible to undertake the studies of Ecuador and Jamaica. Part 1 of this book contains five chapters. Chapter 1 explains the methodology applied in the two surveys. Chapter 2 presents an analysis of the characteristics of the microenterprises surveyed in relation to their size, sector, and location as well as their type of insertion to product (inputs and outputs) and factor (labor and capital) markets. Chapter 3 presents a comparative analysis of the legal framework for small businesses in the coun-

REGULATIONS AND INFORMALITY

5

tries studied and Chapter 4 analyzes the degree of compliance of regulations. The final chapter of Part 1 seeks to statistically determine the importance of factors influencing registration as well as its effect on the growth of microenterprises.

PART 1: REGULATIONS

AND

INFORMALITY

1 The Survey Methodology

This study was based on a general framework and survey questionnaire designed by the Research Programme on Governance and Entrepreneurship of the OECD. The study involved 300 micro and small enterprises (of up to 10 people) in three economic sectors: garment industry, food processing, and equipment repair services. Thirty case studies were also projected in order to further research issues concerning the relationship between informal activities and the laws and regulations in Ecuador, Chile, and Jamaica. A short description for each country of the methodology, the sample frame, and country characteristics follows.

Ecuador Ecuador is a small country with a population of 3.5 million, of which 60 percent is in urban areas. During the early 1990s, the economy has grown at an average of 3.7 percent and employment at 4.4 percent. As a consequence, labor productivity has decreased and informal employment, in which the bulk of underemployment is concentrated, has expanded. The gross national product per inhabitant is US$1,400. In 1992, the minimum wage was US$28, per month urban unemployment was around 9 percent, and the size of the informal sector accounted for 50 percent of nonagricultural labor. One-third of informal employment is in microenterprises. In Ecuador there was no sample frame of small establishments available, so different routes were followed to achieve the requirements of 300 enterprises in specific manufacturing sectors and of predetermined size. The traditional importance of guilds and of different programs of support for microenterprises made it probable that these institutions might have lists with registered enterprises. The list indeed existed, but further fieldwork showed they were significantly outdated. A direct method of searching microenterprises was then followed. Cities were divided into sectors and a

7

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REGULATIONS AND INFORMALITY

door-to-door search was conducted in each of them to find firms that complied with the requirements of size and economic sector. The criteria used were as follows. Of the 300 questionnaires, one-third was applied to each economic sector chosen: garment industry, food preparation, and equipment repair services. In each of these sectors two activities were selected: In the garment industry, tailoring and apparel; in food processing, bakery and food as such; and in equipment repair services, repair of vehicles and electrical household goods. A second criterion referred to the geographical location of the enterprises: half were selected in the capital of Quito and the other half in two provincial towns: Cuenca and Ambato. Finally, businesses had to have no more than ten people working, including the owner. Nonetheless, a small sample of firms employing more than ten people was selected as a control group. Additionally, 10 percent of the firms of ten or fewer people were selected for case studies and the results were used during the analysis of the data survey. Tables 1.1 and 1.2 show the composition of the sample by size, geographic location, and economic sector.

Table 1.1 City

Ecuador: Number of Firms Surveyed by Location and Economic Sector Food

Garment

Repair Services

Total

45 22 22 89

45 22 22 89

45 22 22 89

135 66 66 267

Quito Ambato Cuenca Total

Source: Survey data. Note: Establishments employing up to ten employees are included. The text uses this same size range unless an establishment of more than ten employees is explicitly included as a comparative test group.

Table 1.2

Ecuador: Number of Firms Surveyed by Location and Employment Size Size of Enterprise (number of people)

City Quito Ambato Cuenca Total

Own-account

2-5

6-10

+ 10

Total

16 1 13 30

104 49 45 198

15 16 8 39

15 8 8 31

150 74 74 298

Source: Survey data.

It is very possible that, due to the method of selection, the sample is biased toward establishments of the larger size, as Table 1.2 shows a relatively large number of firms in the two to five employees size. Apparently there is an underrepresentation of own-account (self-employment) firms,

KLEIN & TOKMAN

9

particularly considering that the Jamaican distribution, based on a sample census conducted in 1990, is rather different in that it includes a higher proportion of own-account firms vis-à-vis the other strata of size. The reason for this may be related to the visibility of firms, and this would explain the concentration on firms that have workers and are located outside the home, as will be shown in Chapter 3.

Chile Chile has 13.8 million inhabitants, and its labor force is around 5 million. Eighty-five percent of the population lives in urban areas, and the gross national product per inhabitant is US$2,800. The minimum wage at the end of 1992 was US$102 per month. Since 1984, the economy has been growing steadily at an average rate above 6.5 percent a year and employment has grown at around 4.5 percent per year. Urban unemployment decreased from a very high level in the mid-1980s to an average of 5 percent during 1992-1994. Labor productivity increases were achieved by shifting labor from informal to modern activities. In spite of this improvement, the share of the informal sector in nonagricultural employment is still around 50 percent, and microenterprises account for 40 percent of informal employment. As the sample could not be taken from a known universe of microenterprises, the methodology followed the procedure of selecting blocks in the Gran Santiago area. 1 Each selected block was researched and by means of a short questionnaire of eight questions, the sample microenterprises were identified as being inside households or outside households. For a microenterprise to be in the sample it had to comply with all of the following conditions: • • • • •

The business provided more than half of the income of the declared owner and had been in operation more than one year The area of economic activity was garment, equipment repair services, furniture making, or food processing The business employed fewer than ten persons (including the owner) The total fixed capital of the enterprise had a value of less than US$12,500 and monthly sales of less than US$5,000 2 The owner worked directly, and at least twenty-four hours a week, in the enterprise.

Finally, the size of the enterprises selected in the sample was also controlled. Indeed, 50 percent of the selected businesses employed one worker, 40 percent had two to four workers and 10 percent had five to nine workers. 3 A total of 415 microenterprises were chosen in twenty-nine counties in the area of Gran Santiago, distributed as shown in Table 1.3.

10

REGULATIONS AND INFORMALITY

Table 1.3

Chile: Number of Firms Surveyed by Economic Sector and Employment Size, Gran Santiago

Size Own-account 2 - 5 employees 6 - 9 employees Total

Garment Manufacture

Equipment Repair

Furniture Making

Food Processing

Total

56 44 5 105

52 45 7 104

54 47 5 106

51 44 5 100

213 180 22 415

Source: Survey data.

The survey was undertaken between November 14, 1992, and January 30, 1993. Additionally, thirty microenterprises chosen from different counties in the area of Gran Santiago were selected for further case studies. Three categories of enterprises were included in the case studies: those that had a municipal license (patente municipal), those that also paid value-added tax (VAT) and/or income tax, and those that had no license and did not pay taxes. Finally, a word about the questionnaire. The Chilean study was not originally conceived as part of the larger OECD study, notwithstanding the fact that it used mainly the same questionnaire. Therefore, some questions were different, some were omitted, and others were added. This explains why a strict comparison with the other countries is not always possible, as will be clear during the discussion of data analysis.

Jamaica Jamaica is a Caribbean island with 2.5 million people, of which 1.2 million are economically active. In the 1990s the economy has been growing at an average of 1 percent and employment has grown at 0.8 percent. Informal employment, without including microenterprises, was around 40 percent of nonagricultural labor in 1992, steadily decreasing from a level of 43 percent in 1985. Open unemployment has also decreased during the period 1985-1992, although it remains high, particularly affecting the young people. In 1992, the gross national product per inhabitant was somewhat higher than in Ecuador, at US$1,543, and the minimum wage was US$32 per month. The sample frame was compiled by the Statistical Institute of Jamaica (STATIN) on the basis of a sample census conducted between May and September 1990. A 20 percent sample of districts from the population census was selected, and a complete account was made of all nonagricultural

11

KLEIN & TOKMAN

business establishments. The national estimate for these enterprises by size and employment is shown in Table 1.4. The sample frame did not produce enough establishments in the economic sectors selected in the districts, 4 so a fourth sector, furniture making, was included.

Table 1.4 Jamaica: Distribution of Own-Account and Small Businesses, 1990 Business Category

Number of Businesses

Own-account 1-4 employees 5 - 9 employees Total

Percentage of Total Businesses 73.4 21.8 4.8 100.0

65,135 19,311 4,265 88,713

Employment

Percentage of Total Employment

78,353 45,611 26,980 150,944

53.9 30.2 17.9 100.0

Source: STATIN (1991).

Given that four manufacturing sectors were included in the survey, and these different types of activity were not equally distributed by region or by employment size, the survey sample was divided fairly equally between sectors but unequally by group size and urban or rural location. The distribution of the sample by geographic location is shown in Table 1.5, indicating that 22.5 percent of the interviews were drawn from the parishes of Kingston and St. Andrew, and 77.5 percent came from the rural parishes. As noted above, many of these latter would fall within the area of rural towns, and therefore are not actually representative of deep rural areas. This is made clear in STATIN's report on the sample frame, which points out that 55.1 percent of all of the listed businesses were in areas classified as urban.

Table 1.5

Jamaica: Distribution of the Sample by Economic Activity, Geographic Location, and Employment Size Kingston and St. Andrew

Rural Parishes

Size of Enterprise (number of people)

Economic Activity

Total

Garment manufacture Food processing Furniture making Equipment repair Total Source: Survey data.

19 6 12 17 54

Ownaccount 10 3 3 5 21

2-5

6-10

Total

6 1 6 10 23

3 2 3 2 10

38 48 51 49 186

Ownaccount 27 13 10 9 59

2-5

6-10

9 27 36 34 106

2 8 5 6 21

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REGULATIONS AND INFORMALITY

In this sample, one-third of the garment manufacturing firms were located in Kingston and St. Andrew, in contrast to only 11.1 percent of foodprocessing firms. This low representation of urban food processing firms is related to the inclusion of butchers on the list as well as to the fact that the typical food processing firm engaged in an activity such as canning or even baking tends to employ more than ten workers. For those enterprises engaged in furniture making, 19 percent were in the urban parishes, and 25.8 percent of equipment repairing firms were found in this region.

Notes 1. In contrast to the studies in Ecuador and Jamaica, the Chilean study was undertaken only in the area of the capital city, Gran Santiago (greater Santiago). 2. Equivalent to 500 Unidades de Fomento (U.F.) and 200 U.F., respectively. 3. These proportions roughly correspond to the distribution of microenterprises according to size in the manufacturing sector in Chile. 4. It is interesting to note that one of the reasons for not finding enough establishments was the high mortality rate of firms. In fact, of the 475 firms canvassed, 37 percent of them no longer existed two years later.

PART 1: REGULATIONS

AND

INFORMALITY

2 Characteristics of the Firms

The purpose of this chapter is to describe the economic and social characteristics of the firms surveyed in the countries studied by analyzing certain characteristics of the owners as well as relationships of the businesses with product markets.

Profile of the Owners in the Sample The basic sociodemographic data of owners in Ecuador, Jamaica, and Chile are shown in Tables 2.1, 2.2, and 2.3. Generally, men tend to dominate as entrepreneurs, but the differences among countries are notable. Indeed, whereas in Ecuador women represent only 15 percent of all entrepreneurs, and in Jamaica they are 20 percent, and in Chile they constitute a much greater proportion at 37 percent. In all three countries their importance is greater as own-account workers, particularly concentrated in the garment industry and in the food-processing industry; in fact, in Jamaica and Chile women represent the majority of entrepreneurs in garment manufacturing. How do these figures compare with the overall presence of women in the labor force? In Chile, it is roughly the same, that is, 36 percent of the urban labor force are women. But in Ecuador and Jamaica the involvement of women in the urban labor force is 36 percent and 46 percent, respectively—more than twice their presence as entrepreneurs. As firms grow in size, Table 2.1 shows that owners are older, and particularly that in larger businesses very few young people are owners, even though the Chilean data show that a quarter of firms with six to ten employees are operated by people younger than thirty-five years of age. These data can be compared with Figure 2.1, which shows the relationship between the age of the owner and the age of the firm. In all countries a very clear correlation is observed. The older the owner, the older the firm, thus showing a degree of stability in this occupation (and in the case of Jamaica equated 13

14

REGULATIONS AND INFORMALITY

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15

KLEIN & TOKMAN

Table 2.3

Ecuador, Chile, and Jamaica: Distribution of the Sample by Economic Activity, Employment Size, and Gender Firms Owned by Males

Firms Owned by Females

Size of Enterprise (number of people)

Economic Activity Ecuador Garment manufacture Food processing Equipment repair Total Chile Garment manufacture Food processing Furniture making Equipment repair Total Jamaica Garment manufacture Food processing Furniture making Equipment repair Total

OwnTotal account

2-5

6-10

OwnTotal account

63 53 77 193

15 1 7 23

40 44 64 148

8 8 6 22

26 36 12 74

24 41 97 96 258

7 19 54 49 129

14 21 39 41 115

3 1 4 6 14

24 43 62 63 192

15 9 13 14 51

6 25 41 41 113

3 9 8 8 28

7

2-5

6-10

7

15 25 10 50

4 11 2 17

81 59 9 8 157

49 32 0 3 84

30 23 8 4 65

2 4 1 1 8

32 11 1 3 47

22 7

9 3 1 3 16

1 1

— —

— —

29

— —

2

Source: Survey data.

with larger firm size). Finally, it should be noted that in the Jamaican sample a significant proportion of older entrepreneurs is self-employed. This feature also is common in some Latin American countries where people save during a part of their working life in order to become later independent workers, establishing thus a pattern of occupational mobility and reaffirming the tendency that for some people being independent is a goal in their careers. This is also clearly seen in Ecuador by means of a different, and more complete, set of data that relate the actual occupation of owners by size of the firm with the occupational categories of their first job and the job previous to the present one. Table 2.4 shows that most own-account workers started their careers as wage earners, in contrast to entrepreneurs of larger firms, most of whom have always been owners. The table also suggests a route in the occupational careers of those entrepreneurs that started in a different occupational position and followed an upward mobility pattern. Indeed, most of them began their careers as wage laborers, then proceeded to become apprentices, and then became owners of small firms. The case of Chile is similar to that of Ecuador. Data show both an upward mobility for wage-laborers who become entrepreneurs and a stability of the microenterprise activities as such. Half of the entrepreneurs

Figure 2.1 Relationship Between the Age of the Owner and of the Enterprise ECUADOR 65

D

+-

66-04 -

D

45-64O

35-44

10

5

-t15

- t -

- t -

- t -

20

25

30

35

Age of Enterprise

JAMAICA

66

5

65-64 ~ 45-54 o

35-44

y

30-34 -[ 25-20 - 25

6

10

15

20

25

Age of Enterprise

CHILE

5

10 Age of Enterprise

15

20

25

KLEIN & TOKMAN

Table 2.4

17

Ecuador: Occupational History of the Owners of Firms, by Size of Firm Number of Firms

Percentage of Total

Size of Enterprise (number of people)

Last Occupation Government employee Owner/employer Wage laborer Own-account Nonpaid family member Apprentice The same Total First Occupation Government employee Owner/employer Wage laborer Own-account Nonpaid family member Apprentice The same Total

>10 Total

1

2-5

6-10

1 1 17 0 0 8 3 30

7 2 65 16 10 59 38 197

0 2 7 3 1 8 18 39

2 0 10 2 1 3 14 32

0 2 18 2 0 5 3 30

5 7 88 23 5 31 38 197

2 2 14 3 0 0 18 39

1 0 12 2 1 2 14 32

1

2-5

6-10

>10 Total

10 5 99 21 12 78 73 298

3 3 57 0 0 27 10 100

4 1 33 8 5 30 19 100

0 5 18 8 3 20 46 100

6 0 31 6 3 10 44 100

3 2 33 7 4 26 25 100

8 11 132 30 6 38 73 298

0 6 60 7 0 17 10 100

2 4 45 12 2 16 19 100

5 5 36 8 0 0 46 100

3 0 38 6 3 6 44 100

3 4 44 10 2 13 24 100

Source: Survey data.

working in the areas of equipment repair and furniture making were wage earners in their previous occupation, and one-third of those working in the other two economic activities also were former wage earners, showing that in fact there is a very important role to be played by on-the-job training as a vehicle for social mobility. Additionally, around one-quarter of the interviewed owners of small firms had been own account workers in their previous occupation, so they indeed appear to be a stable group. Even though they may change their activities from one sector to another—or even among firms—they always remain in the positions of owners and/or self-employed. The Chilean entrepreneur is the most highly educated of the three groups—largely due to the better general educational level of the country. This is particularly true in the garment and equipment repair sectors in Chile, but there is no similar trend in the other countries. Indeed, Jamaica also has higher educational levels in the equipment-repair services, which can be related to the need for some sort of technical training, but the level is low in the garment industry and particularly so in the food industry. The latter situation should be further explored because food processing requires stringent health standards, which can be better followed by people who have more education. It must also be noted that in both Chile and Ecuador 40 percent or more of the entrepreneurs have only a primary education. But in the comparative analysis of education related to firm size, no

18

REGULATIONS AND INFORMALITY

clear trend appears for Chile, something that does take place in Ecuador and Jamaica. In effect, almost half of the own-account workers barely have primary educations, a fact that probably is an obstacle not only for the full compliance of laws and regulations but also for increasing the productivity levels of the businesses. There is need then for increased education and training of the owners of informal firms. In addition, a large proportion of ownaccount workers is already old and thus will require special methodologies.

Labor The characteristics of the labor force of microenterprises were researched in Ecuador and Jamaica and partially in Chile. Contrary to the proportions observed in the distribution of gender among entrepreneurs, in the labor force of Ecuador women are more present than in Jamaica; but in both countries the proportion of women is more important in labor than in the ownership of firms (Table 2.5). This is essentially the result of their higher proportion in wage labor concentrated in the larger firms and, as expected, in their strong presence in the garment industry, and to a lesser extent in the food-processing industry. Nonetheless, women are underrepresented in microenterprises in Jamaica compared to their participation rate in the total labor force, considering that globally it is 45 percent. In Ecuador the proportion of women in the sample is the same as nationally in the labor force.

Table 2.5

Distribution of the Labor Force According to Size of the Firm and Gender (percentages) Ecuador

Jamaica

Size of Enterprise (number of people) Total Male Female

63 37

2-5

6-10

Total

65 35

54 46

77 23

2-5

6-10

83 17

69 31

Source: Data survey.

Another feature of labor in microenterprises is that, at least in the case of Ecuador, there is a strong presence of young people, so much so that 51 percent of those employed there are twenty-four years old or younger. At the national level the same age group represents only half of that proportion, 26 percent of the total labor force. Clearly, working in a small firm seems to be an entry position into the labor force, and young people find in microenterprises an early opportunity to work. Thus, from the point of view of human

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KLEIN & TOKMAN

resources, these firms constitute a mechanism for on-the-job training for people starting their occupational careers. As shown in Table 2.6, firms in Ecuador generate more employment than those in Jamaica and Chile, but the structure of the labor force according to their occupational category is rather different among them. In effect, wage employment seems to be slightly more important in Jamaica than in the other two countries because, excluding the owner, it represents 78 percent of total employment of the small firms surveyed, while in Ecuador it is 72 percent and in Chile only 62 percent. Thus, unpaid family workers in Chile and apprentices in Ecuador acquire more relative importance, both in the food-processing sector and in repair services, particularly in the case of Ecuador.

Table 2.6

Distribution of Number of Workers According to Occupational Category and Economic Activity Occupational Category

Economic Activity Ecuador Food processing Garment manufacture Repair services Total Jamaica Food Processing Garment manufacture Repair services Furniture making Total Chile Food processing Garment manufacture Repair services Furniture making Total

OwnEmployer 3 account 3

Wage Earner

Apprentice15

Unpaid Family

Total

97 71 94 262

1 24 12 37

183 151 122 456

16 15 60 91

56 21 3 80

353 282 291 926

36 18 55 49 158

16 37 14 13 80

96 76 111 99 382

1 3 30 42 76

14 2 13 2 31

163 136 223 205 727

35 31 39 37 142

50 56 52 54 212

20 26 38 31 115

1 2 3 3 9

31 9 10 11 61

137 124 142 136 539

Source: Survey data. a. Includes partners when applicable. In the case of Jamaica there is at least one nonresponse. b. In Chile this category corresponds to labor force classified as "others."

Finally, the structure of the labor force in terms of occupational categories shows in all three countries that at the lower level of size there is a greater importance placed on nonpaid family members and apprentices. In Ecuador these categories are, on average, more important than in Jamaica, particularly family members. In fact, family relationships were specifically

20

REGULATIONS AND INFORMALITY

analyzed in Jamaica and it was found that one-third of the labor force in all microenterprises had family ties with the owner; moreover, in those firms with only one employee there was a 50 percent chance that he or she was a member of the family. This percentage increased to 71 percent for garmentmanufacture microenterprises.

Firm Origin and Building Site At these small levels of operation, the overwhelming majority of firms have their origins in the personal initiative of the actual owner of the business: around 90 percent of the cases in Ecuador and Jamaica were started from scratch. The larger firms show a higher percentage of inheritance or purchase of the business. 1 In Jamaica most of the firms were operating from homes or premises that were also family residences, particularly in the case of garment manufacture and furniture making; on average only 30 percent of the enterprises in the sample were located in commercial buildings. The information for Ecuador and Chile is not strictly comparable, but in the samples 60 percent and 56 percent, respectively, of firms were operating outside the owners' homes (but not necessarily in commercial buildings), and, as expected, the smaller the size of the firm the higher the percentage that used the home for its industrial and commercial activities. Small firms are therefore essentially a personal and family affair. This feature is reflected also in the origins of the funds used to initiate the business. In Ecuador and Jamaica, most of the entrepreneurs used their own money or that of their families and friends to start their activities and very few had access and/or used credit. In Ecuador more formal credit was used than in Jamaica, which must be related to the tradition of savings cooperatives in that country, to which many people belong (see Table 2.7). As expected, as firms grow, personal sources of funding decrease and formal credit is used more often. In Jamaica, the limited role played by lending agencies should be set against the proportion of entrepreneurs who stated that they had tried to obtain a start-up loan from this source. Only 20 percent had tried to obtain formal credit (10 percent obtained it), and among those that had not applied about half said they did not need nor like to borrow and almost 40 percent could not comply with the formal requirements needed to obtain such funds (knowledge of procedures, collateral, and so forth).

Insertion in the Product and Input Markets Interrelationships between the micro and small enterprises and the larger establishments seem to be more developed in Chile and Ecuador. Indeed, it

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KLEIN & TOKMAN

Table 2.7

Sources of Initial Capital Utilized by Small Firms (percentages) Ecuador 3

Jamaica

Size of Enterprise (number of people) Own account Own savings Family or friends Formal credit Informal credit Sold assets Others

62 8 25 3 3 0

2-5

6-10

61 11 18 5 4 0

50 8 35 4 2 0

Own account 66 20 2 2 1 9

2-5

6-10

64 15 11 2 4 4

61 10 15 5 7 2

Source: Survey data. a. Multiple answers were accepted.

should be considered that buying from wholesalers and the industry reflects a more advanced degree of linkages than buying from retailers or asking the clients themselves to provide the inputs for the production of goods included in the survey. Table 2.8 shows that almost one-third of the firms buy wholesale in all three countries. In Jamaica the higher linkages with industry and customers suggest that they produce under a putting-out or made-to-order system. These last relationships can be beneficial for the entrepreneur insofar as when the customer brings the inputs it implies that the owner does not have to put out the capital for raw materials and/or spare parts himself. It also probably reflects, therefore, a lower stage of operation and integration with the rest of the economy, which is also the case in Chile, particularly in the garment industry. The case studies in Jamaica suggest that the lack of working capital was one of the problems the firms faced, both because of inadequate support from formal institutions, as will be seen further on, and because they were forced to give credit to customers without being able to enjoy the same benefit in relation to their suppliers.

Table 2.8

Sources of Supply for Small Firms 3 (percentages) Ecuador

Wholesalers Retailers Industry Customers Farms or households Others

35 38 12 10 0 5

Source: Survey data. a. Multiple answers were accepted.

Jamaica 38 54 32 28 16 5

Chile 34 27 13 15 0 11

22

REGULATIONS AND INFORMALITY

In Ecuador, the linkages vary by size of the firm. In Ecuador, only 33 percent of the own-account establishments bought their inputs from wholesalers and 66 percent from retailers. In firms with six to ten employees, 72 percent bought from wholesalers and 25 percent from retailers. This probably means that microfirms may pay more for their inputs and therefore may have higher costs of production than small firms; this tendency was similar in all economic sectors. But in Chile this was not always the case. Indeed, buying from wholesalers was independent of size, and only in the case of supply by retailers, by industry, and by customers was the relationship observed: smaller firms tend to obtain their inputs more from retailers and customers than do larger firms, which buy more often from industry. Most of the small firms pay for their supplies in cash, independent of the economic sector to which they belong. But there is a significant difference between the proportions in Ecuador and Jamaica that pay cash, as seen in Table 2.9. Indeed, in Ecuador almost 40 percent of firms pay their supplies with credit, whereas in Jamaica this proportion is much lower, at 8 percent. It does vary, nonetheless, according to the size of the businesses in both countries, so much so that in Ecuador more than half of the larger firms pay with credit.

Table 2.9

Forms of Payment of Firms to Suppliers According to Size 3 (percentages) Ecuador

Jamaica

Size of Enterprise (number of people)

Cash or advance Credit Other

All

Ownaccount

2-5

6-10

All

Ownaccount

2-5

6-10

61 39 0

80 20 0

67 33 0

47 53 0

87 8 4

90 4 6

89 8 3

74 21 5

Source: Survey data. No data were collected in the survey of Chile, a. Multiple answers were accepted.

On the demand side, the relationships with the state as well as with the private sector were analyzed. Table 2.10 shows that government contracts are not usual in these three countries, even though in Ecuador the proportion of firms receiving government contracts (19 percent) is double that of Jamaica and triple that of Chile. These numbers vary by size of the firm and by economic activity: larger firms tend to receive more contracts, and those in equipment repair services also get more contracts than firms in the other economic activities. In Jamaica, these small percentages are due to lack of

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KLEIN & TOKMAN

Table 2.10

Proportion of Firms Receiving Government Contracts by Economic Activity and Size (percentages)

Economic activity Garment manufacture Food processing Furniture making Repair services Employment size Own-account 2-5 6-10 All firms

Ecuador

Jamaica

Chile

19 13 0 25

7 4 9 12

5 4 3 12

13 18 31 19

1 11 17 8

3 7 22 6

Source: Survey data.

interest and information and the perception that firms need to have political connections in order to obtain such contracts. In Ecuador, lack of interest and information accounted for 75 percent of the reasons for not applying to government contracts. By and large, the overwhelming majority of clients of microenterprises are individuals and local consumers, as shown in Table 2.11. As expected, the smaller the firm the higher the proportion of individuals; this relationship is valid in all three countries. But in Chile, and to a lesser degree in Ecuador, larger microenterprises, particularly in the range of 6 - 1 0 employees, tend to establish stronger linkages with firms than in the case of Jamaica. About two-thirds of them sell their goods to established enterprises and not to individuals, thus suggesting that in Chile and Ecuador the more developed informal sector is more integrated into the economic structure as a supplier of goods and services to economic units. Considered by economic activity, food processing microenterprises, particularly in Ecuador, sell to a higher proportion of firms, even in the lower-size strata. In Chile, on the contrary, the garment industry sells its products principally to firms, indicating that subcontracting is generalized in this sector. At the same time, those private individuals that constitute the main clients of microenterprises in Ecuador and Jamaica generally pay cash for the goods and services they receive. Again, as in the case of payment to the suppliers, the extension of credit varies with size of the firm so that smaller enterprises request mainly cash payment from their customers, even though in Jamaica own-account workers receive cash in only 72 percent of their sales. The rest give credit to their customers, which poses problems concerning working capital availability for many small firms. Indeed, although 12 percent of own-account workers provide credit to their customers, only 4 percent of them get credit from their suppliers; this difference surely brings forward liquidity problems and cash shortages that have their origin in these

24

REGULATIONS A N D INFORMALITY

Table 2.11

Type of Clients by Size of Enterprise (percentages) Size of Enterprise (number of people)

Type of client

Own-account

2-5

6-10

>10

83 6 3 0 9

65 13 3 3 16

37 22 18 6 16

31 23 26 2 17

77 16 5 1 1

48 26 21 3 2

30 34 28 8 0

n.d. n.d. n.d. n.d. n.d.

87 8 1 1 3

84 9 0 1 6

67 13 2 2 16

47 31 7 0 15

2

Ecuador Individuals and local consumers Retailer Wholesaler Manufacturer Others Chileb Individuals and local consumers Retailer Wholesaler Manufacturer Others Jamaica 15 Individuals and local consumers Retailer Wholesaler Manufacturer Others Source: Survey data, n.d. = no data a. U p to three options were accepted. b. R e f e r s to the main client.

asymmetric credit relations. One interesting feature in this sense is the observed opposite situation in Ecuador, where even though small firms work with credit in their relations with suppliers of their inputs, they nonetheless require cash payment from their customers. As was mentioned previously, on average 40 percent of small firms pay their inputs with credit, but only 25 percent give credit to their customers, so there may be some financial profit accrued by this mechanism: buying with credit and selling with cash, which is seen above all in the larger firms. Perhaps the difference among countries may be explained by the higher educational levels attained by entrepreneurs in Ecuador, which gives them a better knowledge of accounting. Additionally, being a Latin American country, Ecuador's experience with inflation must oblige owners of the firms to establish certain behaviors that protect them against the erosion of their income, even though inflation in Ecuador has never been as high as in other countries, such as Argentina, Bolivia, or Chile, to name just a few. Relations with banks and credit were also researched in the surveys. It was already mentioned that not many firms had started up their businesses with formal credit, but, despite the lack of support given by commercial banks in the initial period, a larger proportion of owners went on to establish these relations once their business was under way. As expected, the

KLEIN & TOKMAN

25

degree of such relationships varies with the size of the firm: the larger the firm, the more dealings with the banking system. But in Jamaica, most of the relations are not established in the credit area because only 20 percent of those that do have relationships (on average 45 percent of the firms) get credit. Given these constraints in capital availability, it is not at all surprising that one-quarter of them mention capital problems as the main issue they face today as economic units. In Ecuador, proportionately fewer firms have relationships with banks: only one-third had contacts with these institutions during 1992, and in the garment industry the proportion was less, with only one-quarter of the firms. Of those that had dealings with the bank, only 10 percent had credit. The study also shows a significant correlation between actual use of credit and initial credit, arriving at the conclusion that those that had initial credit also have it now, that is, the relations between a firm and a bank may be a structural feature in the history of the enterprise. Credit was nonetheless available to a higher degree in financing equipment throughout the life of the firm, reaching almost 20 percent of the firms. The Chilean survey shows strikingly similar results. Only one-fifth of the entrepreneurs had applied for formal credit, and one-third of them did not get it (a lower percentage than in Jamaica). Of those that had not applied, 20 percent said they did not need any credit, but most of them were reluctant to have debts. As these data show, access to credit is a complex matter because, on the one hand, formal sources require procedures and standards with which many micro and small entrepreneurs cannot comply and/or do not have, and, on the other hand, most of the owners do not request credit in the first place. Hence, barriers exist on both sides, and an integration of micro and small entrepreneurs to the formal credit system—a link that may be positive to upgrade the enterprise—will have to deal simultaneously with obstacles that exist in the demand and the supply of credit. The surveys in Ecuador and Jamaica also researched the problems encountered by the small firms in their relationships with the market, both as buyers and sellers of goods and services. The results clearly suggest that own-account firms face inadequate demand and lack of customers as the main problems concerning the sales of their products. In fact, 40 percent of all firms in Jamaica reported that they could expand their output, and the same proportion of own-account workers said they lacked customers. In Ecuador own-account workers experienced a decline in demand (43 percent) and an increase in competition (31 percent). Larger firms, in the case of Ecuador, apparently have a more stable demand for their products but face other problems, as is also seen in the case of Jamaica, where obstacles are more related to the supply side of the market, such as the high cost of inputs in general. These difficulties were mentioned by almost 70 percent of all firms in Jamaica when asked about the specific problems they encounter today.

26

REGULATIONS AND INFORMALITY

If microenterprises in fact face stiff competition and a decline in the demand for their goods and services, the question of future feasibility of this scale of enterprise arises. Perhaps in the manufacturing sector own-account firms have little future and their dilemma is that either they grow to become small businesses or they disappear in the short run; maybe the firms interviewed in the surveys of Ecuador and Jamaica are on their path to one of those destinies. This is perhaps the reason why own-account workers in the industrial sector in Latin America—and, of course, in developed countries as well—are decreasing as a share of total employment, and this is valid even in a country such as Ecuador, where there is a strong tradition of artisans and craftsmen. Further data analysis was carried out in the case of Jamaica to obtain the subjective view of firm owners concerning their future, and there was a striking relationship between the size of the firm and the owner's outlook. When the entrepreneurs were asked whether they expected to remain in business, almost 40 percent of own-account workers answered either no or that they were unsure, whereas only 17 percent of those entrepreneurs in firms of more than ten people answered the same. So it is clear that owners of larger firms have a more optimistic view of the future of their establishments. Nonetheless, and having accepted this relationship, it is still noteworthy that 60 percent of own-account workers feel optimistic about their future. Perhaps it is because they feel they can grow, despite data that suggest that as own-account workers in industry their outlook is not very bright.

Note 1. N o data were collected on this aspect in the survey of Chile.

PART 1: REGULATIONS

AND

INFORMALITY

The Legal Framework for Small Businesses in Chile, Ecuador, and Jamaica

An analysis of the legal framework in which the small enterprises of Chile, Ecuador, and Jamaica are involved, shows altogether different systems. In Ecuador there is an almost parallel system of regulations, which applies to microenterprises classified as crafts. This system is operationally complicated and requires undertaking a series of administrative steps in different public units. In Jamaica, on the contrary, there is no special framework for microenterprises, and the procedures to comply with the law are relatively simple. Chile is in an intermediate situation. On the one hand, it has a set of regulations applicable to all enterprises, which are not specifically designed to discriminate by size of firms. On the other, even though several steps have to be taken by entrepreneurs to get the firm legalized, these steps are relatively easy to attain and, comparatively, do not require the use of large amounts of resources in terms of time or of money. The regulations that relate most closely to the operations of enterprises in the countries studied are those that specify the guidelines for business registration, taxation, conditions of production, and work in terms of health and safety and labor laws, including social security. All countries have a wide variety of instruments concerning these areas. Although in general these laws apply universally to all enterprises engaged in business, there are tax exemptions that benefit certain types of firms, and these exemptions are related to the different definitions of firms in each country. In Chile, there is a different tax system for small businesses, which are difficult to monitor and control, but all firms, from a legal point of view, are equal. Therefore, the requirements with which microenterprises have to comply are the same as for the rest of the firms. In Ecuador there is a more complex set of definitions. A microenterprise has been defined in terms of employment: a firm is considered a microenterprise if the number of employees is not more than five. But it has also been defined as a "popular economic unit" for the purpose of access to state support policies, such as those implemented by CONAUPE (Corporación

27

28

REGULATIONS AND INFORMALITY

Nacional de Apoyo a las Unidades Populares Económicas), UNEPROM (Unidad Ejecutora del Programa de Microempresas), and the Banco Nacional de Fomento. In this case the definition refers to capital (not more than 50 minimum wages of capital per job) and type of ownership (collective ownership of its workers). But the most important distinction applies to firms considered to be crafts, defined as "workshops with a total capital of less than 360 minimum wages and not more than 12 workers plus 4 apprentices." There are three laws that regulate these activities: the Ley de Defensa del Artesano of 1953, the Ley de Fomento Artesanal of 1986 and the Ley de la Pequeña Industria of 1985. The main differences between these crafts laws deal with their more or less corporate character. Indeed, the first law is strongly corporate and exclusive, whereas the latter has a more democratic character and accepts more people to be qualified as craftsmen. The other law refers exclusively to small industries. Crafts are given priority access to state credit instruments, tax exemptions, and deferential labor conditions; but at the same time the workers and/or owners must meet certain qualifications to be considered as craftsmen. Additionally, if they want to benefit from the law, it is required that they belong to a guild, a crafts union, or an association of craftsmen. In Jamaica, the typical microenterprise will not be considered a company, which is defined as a firm that has a place of business, is a limited liability company, and is operating under a business name that does not consist of the true surnames of the operators. The legal requirements to operate and the tax obligations are different for companies and persons engaged in business.

Business Registration Business registration is essential, and is the first step in the legalization of the enterprises of Ecuador and Jamaica. In Ecuador firms can be classified as enterprises (including micro) or crafts, and the legal requirements to register vary in each case. If it is a craft, the firm has to (1) register in the Taxpayers Registry (Registro Unico de Contribuyentes), (2) get the acceptance of a government agency that deals with crafts activities (Direccion Nacional de Artesania or the Junta Nacional de Defensa del Artesano—an autonomous institution created by the Defensa del Artesano), and (3) obtain a permit from the municipality (free). On the contrary, if it is a common enterprise—including a microenterprise—it needs to comply with only steps (1) and (3), but has to pay for the permit. Craftsmen who want to benefit from the Ley de Defensa del Artesano have to be certified, which requires having worked at least three years as an apprentice and four as a worker, taking an exam of general culture, and submitting a short dissertation. The 1986 law requires that, in the case of

KLEIN & T O K M A N

29

autonomous craftsmen, the Dirección Nacional de Artesanías evaluates the workshop they possess and certifies that they are affiliated to a guild. Thus, if the firm wants to benefit from the laws that protect crafts activities, the registration requirements are higher than for common enterprises. In Jamaica, firms follow different routes of registration, depending on their nature. The most minimal level of registration for a small business is the Business Enterprise registration, done through the Revenue Board of the Ministry of Finance. The law requires registration for all persons engaged in business as well as all companies, partnerships, sole proprietorships, government departments, and organizations engaged in business activity. For the typical microenterprise, which is likely to be operated by a sole proprietor, business registration requires that an income tax number and a national insurance number be furnished. Each enterprise is assigned a Business Enterprise number (BENO). This number becomes a requirement for successive stages of formalization, such as the application for a Tax Compliance Certificate or for registration for the General Consumption Tax (GCT). Other levels of business registration include registration as a company with the Registrar of Companies, on the basis of which a Business Name Registration Certificate is obtained. The situation in Chile is that all firms have to get a permit (patente) to operate as a business in the municipality. This process has a double function. First, it establishes whether the firm is authorized to be located where it wishes to be, and second, it constitutes an annual revenue for the municipality. Simultaneously, all firms have, by law, to undergo a formal "startingup" of business (iniciación de actividades) with the Internal Revenue Service (Servicio de Impuestos Internos) of the central government. But this requirement can be filled without the municipal permit to operate, so in fact firms can be legal from the taxation point of view and illegal at the municipal level, and vice versa. This situation is analyzed in Part 2 of this volume, and indeed these cases, although not a majority, are significant.

Taxation Policy As can be seen from Table 3.1, in the three countries the same type of taxes apply, but the exceptions provided to persons, crafts, and firms that earn less than a certain level of income and/or are smaller in size are more generous in Ecuador.

Conditions of Production and Work Conditions of both production and work are regulated in the three countries, but with different emphasis. In Jamaica, Chile, and Ecuador, laws concern-

30

REGULATIONS AND INFORMALITY

Table 3.1

Summary of Types of Taxes for Ecuador, Jamaica, and Chile

Type of tax

Ecuador

Jamaica

Chile

Personal income tax

Exemption below annual income of U S $ 2 , 6 0 0 for all entrepreneurs

Exemption below annual income of U S $ 6 4 0 for all entrepreneurs

Exemption below annual income of U S $ 5 , 2 0 0 for all entrepreneurs

Equal for all firms

Special tax for small contributors: the larger of U S $ 4 3 per month or 1 percent of gross income in industry and 2 percent of gross income in services

6 0 percent discount tax on income derived from profits of crafts, if reinvested Business tax

Equal for all firms

Value-added tax

Exemption for all Exemption for firms products produced with gross annual and sold by craftsmen turnover of less than U S $ 5 5 0 , but registration is mandatory

18 percent of sales (IVA) or fixed monthly sum according to average monthly sales, which cannot exceed U S $ 5 0 9

ing the hygienic conditions in the production o f food are important. T h e s e regulations concern the sanitation o f the place where food is produced, the hygienic conditions o f the food handlers themselves, and the quality control o f products. Ecuador, the latter is also extended to other areas o f industry, particularly clothing. In Chile, the municipality is responsible for controlling the conditions o f production concerning the level o f noise and the physical state o f the business (security and advertising mainly). T h e L a b o r Inspection o f the Ministry o f L a b o r controls the conditions o f work, health hazards, and related aspects, whereas the Ministry o f Health determines and controls hygienic standards in the production process o f the food industry as well as the quality o f the goods sold. Data from the survey show that these controls do exist, particularly for the larger firms and for microenterprises in the food sector and equipment repair services, no doubt as a c o n s e q u e n c e o f their greater visibility. In J a m a i c a , within the Bureau o f Standards in the Ministry o f Industry and C o m m e r c e , the F o o d Inspectorate Division has the responsibility for monitoring the production o f all processed food. Certification by this bureau is essential for firms seeking to export their products; it involves a stringent set o f tests in the case o f certain prescribed foods. Firms are charged for

KLEIN & TOKMAN

31

these tests and site visits. More generally, the Public Health Department within the Ministry of Health is responsible for inspections and routine checks of food-manufacturing establishments and restaurants, carried out under the provisions of the Public Health Law. Inspectors are empowered to prosecute in the event that the law is not observed. In Jamaica, a third Ministry (Labor) is also involved in the control of safety, health, and welfare provisions, which are laid out in the Factories Act. There are no distinctions made as to the size of the firms, so all of them have to comply equally with the law, including enterprises engaged in repairs, which are also classified as factories for this purpose. The provisions of this act detail the safety precautions to be implemented with regard to machinery, electrical apparatus, and fire, as well as health and welfare conditions with regard to suitable sanitary conveniences, space, lighting, and so on.

Labor Regulations In the three countries considered, labor regulations are applied to all establishments that employ workers, independent of their size. Nonetheless, in the case of Ecuador the laws and regulations for crafts are different from the ones that apply to the rest of the firms, including microenterprises. The types of regulations are relatively similar in the countries, and in general are similar to those prevailing in Latin America. They essentially concern minimum wages, working hours, contributions to social security, and, in the case of Jamaica, protection against arbitrary dismissal, which is specified in the Termination and Redundary Payments section of the Employment Act. The particular feature of the Chilean case is that contributions are deducted solely from the workers' salaries. It is interesting to note that in Ecuador craftsmen receive special treatment in relation to labor obligations, particularly when they are high in the hierarchy, such as the master of the workshop (maestro de taller). When the master hires workers he is obliged to pay a minimum wage of US$30 per month, plus the contribution to social security, which amounts to 20.2 percent of the minimum wage—10.85 percent to be paid by him and 9.35 percent by the worker. This minimum wage that applies to crafts is 25 percent higher than the minimum wage the rest of firms have to pay (including microenterprises), but crafts are benefited by exemptions from other related costs such as compensatory wage bonuses, two additional wages every year, and other social costs, which in the case of a regular firm amounts to 43 percent of the real wages paid to the workers. Thus it is clear that for a small entrepreneur it is convenient to be classified as a craftsman insofar as he is not forced to comply with the regulations that the labor law specifies for other employers.

32

REGULATIONS AND INFORMALITY

The National Minimum Wage was established in Jamaica in 1974 and has been upgraded at regular intervals in order to offset some of the reduction in purchasing power due to rapid inflation. An increase took effect on July 6, 1992, establishing a minimum wage level that is double the one that applies to workers of crafts in Ecuador, and is the same for all categories of workers. The Minimum Wage Law also specifies hourly rates of pay and overtime rates, as well as a weekly rest day so that employers are not at liberty to extract extra hours of work for a fixed sum. The Employment Act in Jamaica provides minimum standards for notice to be given on termination of employment, and allows the payment of wages in lieu of this notice. Where employment is terminated because of redundancy, the act sets out a schedule for compensatory payments. Whereas the above regulations are the particular responsibility of the Department of Labor, social security provisions for workers in Jamaica are part of the National Insurance Scheme (NIS). This is a contributory scheme under which employers are required to deduct NIS payments for all workers. The monthly deduction for NIS is only 2.5 percent of the monthly wage, up to a ceiling of J$ 1,256 (US$1 = J$22.4, approximately) monthly earning, and thus the deduction to workers cannot exceed J$31.40 monthly, which is a notably small amount compared to the deductions in Ecuador, considering additionally that in Ecuador the wage is half that in Jamaica. This deduction to the worker is matched by a contribution from the employer, and this is also the case for deductions made for the National Housing Trust (NHT) program. NHT contributions are higher: they amount to 2 percent of gross emoluments from workers and 3 percent from employers. Chilean firms have to comply with several labor laws, similar in nature to their Jamaican counterparts. First there is a minimum wage, established at a national level, with no differences allowed for types of firms or economic sectors. Second, the law stipulates compensation when employment is terminated due to redundancy. Third, the law comprises the usual articles related to holidays, working hours, overtime rates, and conditions for night shifts, among the most relevant. The important aspect to be considered is that in Chile the labor laws do not make exemptions or allow for special conditions for microenterprises, as in the Ecuadorian case. There are three different mandatory security provisions for workers employed in enterprises. They relate to health protection and pension funds, and a particular feature of the Chilean system is that the contributions to these systems are basically financed by the worker. For workers with permanent contracts, deductions amounting to an average of 22 percent of gross salary are made: 7 percent for health protection, 13 percent for pension funds, and a small 2 percent to cover a labor accidents insurance paid by the employer. Self-employed workers may contribute voluntarily to these schemes, and in general the actual coverage is rather high. Indeed 70 percent of the self-employed in the survey made contributions to both the pension

KLEIN & TOKMAN

33

fund and health insurance, and an additional 11 percent contributed only to their health insurance.

General Remarks The legal framework in Ecuador has a set of rules that on the one hand regulate the activities of microenterprises and on the other hand benefit their activities vis-à-vis larger enterprises. In Jamaica the benefits are essentially limited to certain tax exemptions. The rest of the regulations that apply to microenterprises are basically the same as those in force for other firms. This is also the case in Chile where there are no special laws to promote microenterprise activities. As opposed to the Jamaican case, tax exemptions in Chile that in fact may benefit small firms do so because they are directed toward firms with difficult fiscal control (which they are) and not because of their size in employment terms or because there is a special support program for microenterprises as such. On the contrary, in Ecuador there are special laws to promote microenterprise development in general and crafts in particular, and they create a certain degree of economic protection by means of decreasing their costs of operation, therefore improving their capacity to compete with other firms. These protective measures usually require entrepreneurs to comply with more regulations and administrative procedures than the ones common firms have to deal with in the same country, or similar enterprises in countries where there are no special promotion regimes, as in Jamaica or Chile. In effect, in a comparative regional perspective, Ecuador stands high among Latin American countries, both in terms of cost of registration and time devoted to get it (Tokman, 1992). In the industrial sector, it takes between 180 and 240 working days to get registered in Ecuador, compared with 3 0 ^ 5 days in Bolivia and Brazil, which represent the lowest echelons in the rating, and 65 days in Chile. Furthermore, the administrative steps required for registration in Ecuador are thirty-nine, the highest in the region, thirtyfour of which are required for a microenterprise to be classified as a craft and thus get access to the benefits the special laws provide. In Chile, the number of steps for registration is four, the lowest in the region, as is also the case in Bolivia and Guatemala. In terms of cost, it has been estimated that the registration of an industrial firm in Ecuador can amount to almost 25 percent of the annual profits of these firms. But the analysis made in Ecuador suggests that it may be useful to distinguish, on the one hand, the nature and number of laws and rules that have to be followed, and on the other hand, on the capacity or will of the state to enforce these laws. Although the number of regulations is indeed large, it coexists with a sort of absence of the state in their control, perhaps also guided by the knowledge that the capability of these microenterprises to pay and

34

REGULATIONS AND INFORMALITY

follow every law is limited. In a different way, this gap is also observed in Chile. Indeed, although benefits that can be used by small firms do exist, they are generally absent in the operation of microenterprises.

PART 1: REGULATIONS AND

INFORMALITY

Compliance with Regulations

It has been pointed out in Chapter 3 that the legal frameworks in Ecuador, Jamaica, and Chile are different insofar as Ecuador has a defined set of rules that apply specifically to the microenterprises classified as crafts, with the purpose of promoting and benefiting their activities. On the contrary, in Jamaica the law in general is applicable to all firms, even though there are some particular instruments that are designed to benefit small-scale business as well, such as tax exemptions. Chile does not have a legal framework specifically designed for microenterprises. This chapter analyzes the degree of compliance with these laws and examines the relation between compliance and different aspects of the microenterprises.

The First Basic Step: Legal Existence of the Firm All firms have to be registered in order to establish themselves as either a business or an economic activity. This means that in Ecuador they have to get a RUC (taxpayers' registry) in Jamaica a BENO (registration number), and in Chile a patente (license). The degree of compliance with this first step is significantly different in each country (see Table 4.1). In Ecuador the degree of registration is higher than in the other countries, except in the upper strata of firms in Chile, where almost all firms are legal. As expected, in Ecuador it is also higher in the capital city than in other cities. But in Jamaica it is uniformly low, independent of the geographic location of the firms. Registration degree varies with the size of the establishment in the countries, and, as expected, larger enterprises register more frequently than small ones, particularly in Jamaica where for ownaccount workers registration is practically nonexistent. Registration also varies with the economic activity of the firm, and in the three countries more visible firms (particularly repair services) register more often than activities that can be carried out inside the home (mainly the

35

36

REGULATIONS A N D INFORMALITY

Table 4.1

Firms with Business Registration According to Size and Location (percentages) Registered Firms

Size and Location Sizeb Own-account

2-5 6-10 Average Location Capital 0 Restd

Ecuador

Jamaica

50 65 79 69

4 26 60 23

75 45

25 22

Chile3

42 64 91 55

Source: Survey data. a. In Chile the survey was undertaken only in Santiago, the capital. b. N u m b e r of workers, including the employer. c. In Ecuador it refers to Quito and in Jamaica to Kingston and St. Andrews. d. In Ecuador it refers to Cuenca and A m b a t o and in Jamaica to rural parishes.

garment industry). Moreover, data on gross monthly sales of firms in Jamaica and Chile also indicate that firms with higher sales register more often than those in the lower strata. Finally, data on Ecuador show that firms that have existed for a longer period of time have a higher proportion of registration, so much so that firms in business more than twenty years are registered in 86 percent of the cases, whereas only half of those recently established (1990-1992) are registered. One of the reasons there is greater compliance with registration requirements in Ecuador is that registration is the first step in a chain of requirements that can bring forward economic advantages to the small firms. Indeed, it may be recalled that in Ecuador in order to qualify as subjects of the promotion laws that are directed toward the activities of craftsmen, firms have to follow certain procedures to be classified as crafts, and the business registration (RUC) is the first stage in this process. Thus, legalizing the firm in Ecuador is linked to economic benefits and is not just a case of potential higher costs under the form of taxes and/or labor-related expenses, as may be true for Jamaica or Chile. This seems to be particularly true when the analysis of the reasons for compliance with existing regulations is brought forward. Small producers in Ecuador in general have high degrees of compliance with regulations because even though it implies high costs this comes pari passu with benefits, and not—and this is important—because the state control of compliance is strict. In effect, of those firms that do not comply with taxes regulations, the most important single reason for evasion is that there is no control and/or that sanctions are light, so it is not worthwhile to pay taxes. But there is practically no mention of the objective fact that, as was mentioned in the

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previous chapter, in Ecuador it is difficult, costly, and time consuming to be legal. On the contrary, in Jamaica the "no enforcement" reason is scarcely mentioned; among those who did not support compliance with labor regulations, the overwhelming majority referred to bureaucratic obstacles. Which hypothesis can then explain the Chilean situation, which presents a relatively high degree of compliance with the municipal license, on the one hand, and a lack of access to direct promotional benefits for those that have a license, on the other? One aspect that may in part explain this situation is coercive in nature, as will be further analyzed in Chapter 5. In fact, 60 percent of all firms surveyed had been visited during the preceding year by a municipal inspector, who checked for valid and up-to-date licenses. Obviously, smaller firms were less visited, no doubt because they are hidden inside the house; larger firms of six or more employees face a different situation, so much so that 86 percent of them had been inspected during the last year. In this aspect, then, Chile is clearly different from the other two countries studied because, as opposed to the Ecuadorian case, of those firms that did not comply, the lack of control was not among the reasons given by entrepreneurs to explain their situation. Most said they had no license because they did not meet all the necessary requirements to obtain it, and when further asked about the obstacles to get one, one-third of them mentioned bureaucratic issues. To sum up, the degree of compliance with regulations is, first, apparently linked to potential benefits that can be obtained through the achievement of a legal status for the firm. This means that the costs involved in the process have to be examined in relation to potential benefits. Second, when these benefits are absent, then coercion under the form of state control can explain a higher degree of compliance. Lack of compliance can then be explained mainly in relation to the absence of benefits, the lack of control, and the degree of difficulty in acquiring that status in terms of time, trouble, complexity, and costs. These issues are discussed below.

Labor Laws Compliance with labor laws was analyzed in the surveys in relation to three variables: size of the business in terms of volume of employment, geographical location (except in Chile), and sector of economic activity. The results are summarized in Tables 4.2, 4.3, and 4.4. Of all labor regulations, the minimum wage law is the one most followed in these countries, although, once again, with significant differences in the degree of compliance. Whereas in Chile and Ecuador almost all firms comply with the law, independent of their size, in Jamaica less than half do so, with a higher degree of compliance in the larger firms. The explanation may partly be due to the fact that in Ecuador the minimum wage a craft must

REGULATIONS AND INFORMALITY

U

w ° "so XI S « G

10

54 15 13 50

43 29 14 20

57 12 11 50

49 24 16 67

39 36 21 66

Note: A maximum of two answers were accepted.

In the case of enterprises with up to ten workers, half of the sampling stated it had some type of regulation. Within those regulated enterprises, the rules referred to, generally, hygienic, technical, and product quality conditions (see Table 14.2). However, the report on enforcement of regulations is low in the case of own-account workers and high concerning enterprises with close to ten workers. Also, the variety of regulations is higher due to the fact that for microenterprises the sanitary rules are less predominant than the technical and product quality regulations. Location seems to have no significance in this analysis; on the other hand, the area of activity is a key element. The food processing enterprises are the most subject to regulations (81 percent are regulated), and the hygienic regulations for this sector were reported as very important (69 percent). It can be said, therefore, that in general terms, the importance attained by the regulations in the sampling must be interpreted in the light of the incidence that such regulations have for the food processing enterprises. The analysis of the enterprises with more than ten workers reinforces this trend in the sense that these are more regulated and that the diversity of regulations that they have to observe is, in this case, higher than those for smaller enterprises.

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The enterprises with more than ten workers, in addition to the above regulations, reported to be subject also to restrictions on prices (39 percent of all cases). The analysis by area of activity also disclosed significant differences within this group of enterprises as well as within the smaller enterprises of this same area of activity. Thus, it was found that the garment manufacturing enterprises have only two types of regulations: technical regulations (80 percent) and price regulations (20 percent). Within the group under review, the incidence of the food processing enterprises for the overall regulatory profile is less than the group of enterprises with fewer than ten workers.

Microenterprises and Tax Regulations Single Registrar of Taxpayers Half of the own-account workers are RUC holders, increasing to almost 80 percent of the enterprises with six to ten workers. The average percentage of RUC holders for the group of enterprises with up to ten workers is 69 percent. For enterprises with more than ten workers, practically all (94 percent) are RUC holders. Income Tax For enterprises that pay IR, or state to be exempted from such payment, 60 percent of all enterprises with one person meet these conditions, increasing to 95 percent of the businesses with six to ten workers. Enterprises with more than ten workers also have a 95 percent compliance rate. The average for IR payers in the group of up to ten workers is 82 percent. However, if we consider only the exemption status, this trend evolves in the opposite direction: 27 percent of the own-account workers are exempted, whereas only 15 percent are in the six to ten worker businesses. Those with more than ten workers do not state an exemption status. Value-Added

Tax

Sixty percent of own-account workers are paying or are exempted from the VAT. The trend is toward greater fulfillment for larger size enterprises (87 percent for those with six to ten workers). In the case of this tax, exemption does not vary with size of the enterprise, as occurs with the rest of the taxes. The average rate of enterprises that pay VAT for this group is 72 percent. In businesses with more than ten workers, 93 percent fulfill the VAT commitment, with 19 percent of these being exempted.

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Municipal

ECUADOR

License

As regards payment for a municipal license, 2 4 0 percent of the own-account workers fulfill this commitment; this compliance increases significantly for enterprises with two to five workers (78 percent), reaching 9 0 percent of the enterprises with six to ten workers. Exemption of payment evolves in the opposite direction, from 17 percent of own-account enterprises down to only 3 percent in the six to ten workers range. The average payment or exemption for P M for enterprises of up to ten workers is 75 percent. Almost every enterprise with more than ten workers pays the license and no exemptions are registered. Therefore, there is a positive correlation between the level of fulfillment of the various tax regulations and the size of the labor force within these enterprises (see Table 14.3). There is also a negative correlation with the exemption status from these regulations: as the size of the enterprises increases, the percentage of exempted businesses decreases. Finally, the performance of the enterprises in the range of six to ten workers is very close to that of those enterprises employing more than ten workers, particularly in payment of income tax and municipal license.

Table 14.3

C o m p l i a n c e with Tax R e g u l a t i o n s b y Enterprise Size (percentages) Size of Enterprise (number of people)

Regulation RUC Holders IR Pay Exempted Pay + exempted VAT Pay Exempted Pay + exempted PM Pay Exempted Pay + exempted Total cases a

1

2-5

6-10

Up to 10 (average)

> 10

50

70

79

69

94

33 27 60

60 23 83

79 15 94

60 22 82

94 0 94

23 37 60

35 36 71

54 33 87

36 36 72

74 19 93

23 17 40 30

73 6 78 198

87 3 90 39

69 6 75 267

90 0 90 31

a. Absolute values.

Tax compliance varies from one city to another, depending on the type of tax, so it is impossible to draw a straightforward conclusion. Indeed, higher levels of compliance are observed in Quito for the R U C , and for the IR Ambato also has a high degree, whereas VAT is lower in Quito than in

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Cuenca and Ambato. The general average is around 7 0 - 8 0 percent of enterprises employing up to 10 workers fulfill their tax obligations, compared with more than 9 0 percent in firms employing more than 10 workers. Rates of exemption are similar in general, showing obviously that size and perhaps sector of economic activity are the relevant variables that determine whether the firm has to pay taxes. T h e data suggest that tax compliance is lower in the garment industry; this must be linked to the already-mentioned characteristic of that being a household activity with low visibility. In the food processing and repair services sectors, the rates are higher and rather similar. The dynamic evolution o f microenterprises clearly shows that older firms have significantly higher rates of tax compliance. For example, in relation to R U C , firms that have been operating for more than twenty years have a rate of fulfillment of 8 6 percent whereas new firms with less than two years of existence have a rate of 5 2 percent. Therefore, the process of legalization of microenterprises is clearly something that is achieved throughout the years of operation. The percentages for VAT are 9 2 percent for older firms and 5 6 percent existence less than two years (including firms that are exempted). Finally, if we analyze the average figures for total compliance with tax regulations (including those that are exempted), we see that over half of them ( 5 2 percent) are in this bracket for the group of up to ten workers (see Table 14.4); for those with more than ten workers this overall performance is almost the norm (87 percent). B y keeping this trend for each of the tax categories already reviewed in this chapter, it can be appreciated that ownaccount workers are showing fewer cases of overall fulfillment (17 percent), whereas when the work force is at least two, this fulfillment is reached by at least half of all the enterprises considered.

Table 14.4

Total C o m p l i a n c e and E v a s i o n of Taxes b y Size of Enterprise (percentages) Size of Enterprise (number of people)

Total compliance Total evasion

1

2-5

6-10

Average

17 30

53 10

72 3

52 11

B y cities, Cuenca-based enterprises have an average level of fulfillment, which is slightly less than their opposite numbers in both Quito and Ambato, but, as was mentioned, this average hides a rather heterogeneous reality. Likewise, when the analysis is focused on the area of activity, there emerges a lesser overall fulfillment among the garment industry enterprises. Finally, the historical overview allows us to detect that the ratio of newly

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started enterprises that reach global fulfillment (27 percent) is considerably less when compared with those that started prior to 1990 (half of them). On the other hand, total overall evasion of the regulations considered amounts to 11 percent of the enterprises with up to ten workers (Table 14.4). This overall view confirms the trend observed separately for each tax law regarding enterprise size, areas of activity, and year of initiation. In the analysis by cities, Quito shows a slightly higher frequency of overall evasion than Ambato and Cuenca. The results show a tendency partly similar to the one already noticed in Part 1 concerning the dichotomy of underground-fully legal enterprises, that is, that many firms are in a gray area. Table 14.4 adds to that consideration the element of size, which shows that the gray area is larger in the smaller scale of firms; as size increases, the percentage of firms that are completely underground practically disappears and the gray zone is not so important. Regarding the reasons for not fulfilling tax commitments, 3 the main one is the weak presence of the state in enforcing such commitments, as stated by the two following answers to the questionnaire: (1) "far in between inspections and light fines or sanctions"; and (2) "have not been compelled to pay." Thus a weak presence shows up due to the lack of control as well as fines and sanctions that are not too heavy. This reason for evasion of the three taxes is stated by almost half of the offending enterprises (48 percent in the case of income tax, 40 percent for VAT, and 46 percent for the municipal license). The other reason for tax evasion is lack of knowledge about the need to observe the respective commitments. Here the variation by tax law is less homogeneous, showing up particularly with VAT in 51 percent of all cases, whereas income tax is 31 percent and municipal license is 28 percent. The other reasons quoted 14 involve less than 25 percent of all offending enterprises. A review of reasons for tax evasion by areas of activity, cities, and years of initiation do not show any significant variations, especially when considering the number of cases.

Notes 1. This answer was basically considered when the workers of a specific enterprise had close family links with the owner (e.g., wife, son), when a worker had been hired part time, or when it was the case of workers (both workers and apprentices) who by law can have lower wages than the general SMV. 2. There is the possibility of being exempted from paying for the municipal license, but businesses are not exempted from having it. 3. In this paragraph we are not dealing with the exemption, since due to the previous presentation, we have considered it as a form of fulfilling these regulations. 4. Other reasons include the following options: "administrative procedures too complicated or too protracted," "very expensive," and "others."

PART 3: ECUADOR

15 Support to the Microenterprises: Guild Associations and Bookkeeping

We analyze in this chapter the subjects related to various support schemes aimed at encouraging the activities of microenterprises, and also other aspects related to guilds because of their importance with respect to the relationship set up with the state as well as the access to certain tax exemptions and other benefits. The level of attachment to some development promotion laws 1 for enterprises with up five workers is around 50 percent, whereas in the case of enterprises with six or more workers it exceeds 70 percent of the total. Depending on the specific support law, enterprises with fewer workers attach themselves to the Law for the Defense of the Artisan (40 percent of the own-account workers and 10 percent of those with more than ten workers), and as the number of workers goes up, there is a greater rate of attachment to the Law for the Promotion of Handicrafts (ranging from 7 percent to 16 percent for the same size ranks), and particularly to the Law for the Promotion of Small Industry, with ratings of 3 percent to 45 percent. The latter makes sense, due to the fact that larger enterprises can be rated as "small industries." Regarding the artisan qualification, those enterprises attached to the Law for the Promotion of Handicrafts are smaller in terms of work force than those attached to the Law for the Defense of the Artisan. To the survey question, "Have you received any support, in the form of training or advice, from any entity or support scheme aimed at the microenterprise?" about 20 percent of all enterprises responded positively, without any significant differences according to size. This percentage, high as it may look, does not differentiate at this level of answer whether the source of this support was public or private, national or international, nor does it indicate its duration and qualitative nature. The proportion of microenterprises associated in guilds varied according to size. Indeed, for businesses of up to five workers, membership in a guild association is held by 50 percent. Enterprises that exceed five workers have registered membership ratios exceeding 70 percent. This important

147

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ECUADOR

volume of association, in general terms, explains the levels of tax exemptions discussed in Chapter 14, which focuses on tax regulations. The linkages of microenterprises with promotional laws present differences according to the city. For enterprises with up to ten workers, in Ambato three out of four register a level of attachment to promotion laws, higher than for the Quito or Cuenca enterprises (two out of four). This may be due to the fact that in Ambato the organizational structure of small economic activities is more consolidated than in the other cities. This hypothesis gains confirmation if we pay attention to what happens with access to the support made available to the microenterprise (33 percent of the enterprises in Ambato, as opposed to 16 percent and 8 percent in Quito and Cuenca, respectively); and more so with respect to membership to a trade association (Ambato has 79 percent, whereas Quito and Cuenca are at 36 percent and 47 percent, respectively). However, within the enterprises with more than ten workers, this is not immediately obvious, because in this case Quito has a higher degree of attachment to promotional laws (80 percent, as opposed to almost 64 percent for both Ambato and Cuenca). However, in Ambato there is still greater access to support (38 percent of these enterprises, as opposed to 20 percent in Quito and less than 20 percent in Cuenca), plus a larger membership to a guild association (in this respect together with Cuenca the percentage is 88 percent, whereas in Quito it is 67 percent). It is almost certain that the small number of cases for this enterprise strata do not allow for the setting of a trend. Among the enterprises with up to ten workers, the garment and repair services activities look more akin in the aspects we are reviewing, as opposed to the food processing activities. Garment manufacturing and repair services are the sectors that in greater ratios attach themselves to a promotion law (each at more than 62 percent with food processing being only 41 percent), and register higher levels of trade association membership (over half whereas food processing is 36 percent). In access to support available to the microenterprise, garment manufacturing manages to secure more help (27 percent as opposed to some 15 percent secured by the other areas). The year of initiation into business offers correlations that show that the older the enterprises are, a greater proportion of them get attached to a law, as well as becoming members of a guild association. Regarding access to support made available to microenterprises, there is no clearly identifiable trend from a historical viewpoint. Maybe 27 percent of the enterprises created prior to 1970 gain access to the support, as opposed to those created in other periods, which show ratios closer to 18 percent (with a tolerance ratio of 4 percent either way), which suggests that the older enterprises are enjoying more privileged support than the other enterprises. Summing up, regarding the aspects of support and trade association membership for the enterprises included in the survey, a predominant pro-

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file emerges that the larger the enterprises are the higher the percentage of attachment to any promotional law. On the other hand, the smaller the enterprises are, the more they tend to attach themselves to the Law for the Defense of the Artisan. Disregarding enterprise size, one out of five microenterprises receive some type of specific support. Also, size appears to have some correlation with the percentage of trade membership, however the latter is rated for at least half of the total number of enterprises. This profile is indeed met in Ambato, whereas by area of activity the garment manufacture and repair services sectors show these features more regularly. Regarding the bookkeeping and management angle, we analyzed the options of having available a basic personal registrar (nonsystematic followup of income and expenses) or a formal general accounting system, which allows for balance of accounts, inventories, and so forth. Within the group of enterprises with up to five workers, it is the norm not to have these last systems (over half, and even more among the smaller units); but this pattern changes among the enterprises with more than five workers, particularly with the increase in the ratio of enterprises operating general accounting systems (36 percent of those in the range of six to ten workers, and 58 percent among those with more than ten). In any case, the use of a personal register for the latter is not infrequent (one out of four). The breakdown by cities where these enterprises are based regarding the personal register, 24 percent to 33 percent of the enterprises keep it. But in Ambato there is an important ratio of enterprises that keep general accountancy systems (23 percent), as opposed to those based in Quito (4 percent) and Cuenca (6 percent). The date of creation of the business does not mark a clear trend when it comes to the utilization of accounting systems, but it shows a curious phenomenon in the sense that the older and newer enterprises have a higher proportion of those keeping some sort of accountancy (almost half); but almost 75 percent of those created in the period 1980-1984 do not have these systems in place. Is it experience and/or force of events that has persuaded the older enterprises to bring in bookkeeping practices, while the more recently created ones are benefiting from the use of simplified account control methods? The access to support schemes aimed at the microenterprise is coming closer (at an insufficient rate yet to lead to any conclusion) toward making the use of accountancy more widespread.

Note 1. The laws considered are (a) Law for the Promotion of Handicrafts, (b) Law for the Defense of the Artisan, and (c) Law for the Promotion of Small Industry.

PART 3: ECUADOR

16 Conclusions

This chapter presents our conclusions from the survey on the small urban enterprises operating in Ecuador. First, by way of synthesis, we highlight the predominant features of the survey by size, city, and area of activity. By crossing a variable with the size of the work force we can often visualize a coherent enterprise distribution. Quite the reverse actually happens when focusing by area of activity or by city, which does not always allow so obvious a reading along the work force ranks. Last, we outline some analytical implications of the survey, which are issued in the way of a working hypothesis. In each chapter of Part 3 we have emphasized the importance of enterprise size. However, what we have not touched upon is something worth highlighting. The survey included a special comparative ceiling of ten workers; thus, enterprises with more than ten workers could be considered as a sort of "control group" against which, by contrast, a comparison could be made on the way enterprises with up to ten workers were operating. These considerations confine the discussion on the criteria that must be considered, while introducing relevant ceilings that allow for a breakdown of enterprise subgroups that present certain homogeneous features. Without moving sideways into that discussion, we have to say that a ceiling based on only one variable (size of the enterprise, measured by number of workers) in some cases appears to be insufficient to account for the qualitative changes that have been observed. Although on many occasions this empirical difference was useful, in others it proved irrelevant because the limit that appeared to make a qualitative difference, both on the structural features of the enterprises (especially their work force, setting-up systems, equipping, and affiliation to trade unions), as well as on their dynamic peculiarities (relation with the market for goods and services, access to credit, and fulfillment of commitments) appears to be positioned in a lower rank, that is with six or more workers; for certain variables this limit is as low as three or more workers.

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The fact that the number of workers that distinguishes microenterprises from small industries differs with the variable being considered becomes particularly relevant for the structural characteristics, such as the work force within the enterprises, already described in Chapter 11; for the case of enterprises with less than three workers, as a mix between market labor force ("free") and workers with a series of family, friendship, and other ties, which have not formalized their relationship with the owners of these enterprises, and which we have called "linked up" labor. Other structural characteristics that are significantly interrelated with enterprise size in the case of those with up to two workers are their starting system and their affiliation. For the starting system, it was found that what we have called "personal initiative" is an important factor, whereas in the enterprises that have a larger number of workers, there are other starting systems that entail, more than starting an economic venture, a continuity of an ongoing enterprise (purchase or inheritance). Regarding the affiliation angle, we have detected that small enterprises (measured by the number of workers) tend to stay with the Artisan Defense Board, an institution to which we made reference in our introduction as the "institutional framework" and whose characteristics get closer to the traditional logics of craftsmanship as opposed to entrepreneurial logics. Those aspects over which enterprise size bears more weight are those referred to the dynamics—that is, the set of relations with the market of goods and services, with the tax laws and regulations, and with the capital markets. For these aspects, the ceiling of six workers, and even more those of ten, achieve a great relevance. Those enterprises that could empirically be defined as "large" within the context of our survey show up as more dynamic than those positioned below the empirical ceiling of six workers (which would admit their branding of "small"). Particularly for those variables of market for goods and regulations, the large enterprises show a greater diversification of clients and suppliers as well as differences pertaining to the incidence of the wholesale clients and suppliers. All of which has an even more contrasting importance if they are compared with what happens with smaller enterprises. Likewise, the agreements reached by the large enterprises with their clients and suppliers entail a greater flexibility concerning payments (on both sides of demand) than among the small enterprises. Regulations, in their aspects pertaining to entrepreneurial commitments, also have differences in their dynamics regarding enterprise size. The larger enterprises showed a more developed fondness for fulfilling their commitments than did small enterprises. The ceilings, on one hand, become more fluid in those aspects related to capital markets, and on the other, it looks as though size is a less relevant element than in the case of variables analyzed hitherto. However, when we refer to arrangements with banks or the investment of capital in business premises, enterprise size becomes relevant again. The larger enterprises

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have more numerous and frequent relations with banks, and generally have incurred in a capital investment through the purchase of premises needed for their operations. The reverse shows up with small enterprises, especially when their worker numbers get close to one; indeed, these enterprises would appear to be relatively more isolated from the banks and they generally rent out the premises from which they operate (although it is not infrequent to find enterprises that own the premises). Equally, access to promotion laws becomes a fact more often when it entails larger enterprises, and the same applies to the prospect of trade association membership. With what has been stated so far, we could draw a conclusion that the larger the enterprises become, the trend is to lead their business within the terms of entrepreneurial logics; that is, bearing in mind their growth perspectives, the expansion of their markets, and a more capitalist approach than their small counterparts. As regards the latter enterprises, we would be talking more o f a logic of subsistence, of a strategy aimed at securing both an income and a j o b , which, first and foremost, allows the owners and employees to take in their hands their personal and family reproduction, but with little relevance to what is concerned with activity growth and dynamism. Considering the more relevant aspects in each city, we have noted that in the case of Quito, these refer to the structure of labor by gender (ratio of men to women is two to one, whereas in Ambato and Cuenca the ratio is almost one to one). Workers' affiliation in Quito is different in the sense that for enterprises with up to ten workers, the affiliation rate is the lowest, whereas in the case of enterprises with more than ten workers, Quito ranks the highest of all three cities. For Quito, we have verified a relatively weak level of bank credits for starting up businesses, but a high level of savings. Also, for equipping businesses, the importance of supplier credits stands out over and above bank credit. Added to this is the observation of a relatively low level of bank arrangements and connections compared to the enterprises based in the other two cities. The fact that Quito has the largest number of enterprises that have undertaken no equipping initiatives during the period 1 9 8 9 - 1 9 9 2 , is not surprising. Regarding tax requirements, we noted that in Quito the level of R U C holders and income tax registered taxpayers is the highest of the three cities. But the opposite is the case with the fulfillment of VAT and the municipal license. Ambato has a specific profile. The work force has the highest proportion of labor with no family links, the highest presence of wage earners, a high proportion of written contracts, and a particularly high growth of labor (more so in the six-to-ten-worker category, where the rate of increase of up to two workers represents 7 0 percent of total cases). Strong competition is remarkable in Ambato, all in line with its strong economic activity.

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Regarding labor tax evasion, that referred to the minimum wage is considerable, and generally speaking the level of fulfillment of commitments with the labor force is lower in Ambato than in the other two cities. The interesting point is, however, that the level of fulfillment of the tax commitments is higher, particularly with income tax, value-added tax, and the municipal license. Likewise, the attachment to any promotion law in Ambato is high (three out of four enterprises), as well as the access to support schemes aimed at the microenterprises. This factor can influence the fact, as far as Ambato is concerned, that there is a more formal approach to account management, particularly in the case of general accountancy systems. The importance attached to supplier credits is considerable, with a view to ensure the supply of the required raw materials, and with a high rate of enterprises granting credit to their clientele and using deferred payment terms made available by their suppliers. Finally, the high level of affiliation to a guilds association among the Ambato enterprises must be highlighted, with a good organization of the guilds associations evidenced during the fieldwork stage. All the above confirms the economic dynamism prevailing in Ambato, which is characterized by a higher profile with the banks and also a higher investment frequency in the period 1989-1992. In Cuenca, focusing on the marketing and servicing difficulties experienced there, there was particular mention of a drop in demand, which could be the reason for our findings related to a highly unstable work force. Also there is a higher level of enterprises located apart from the home and a lower level of enterprises inside the house, facts which almost certainly explain why Cuenca has the highest level of rented properties. We also looked into the importance of bank and supplier credits in Cuenca for businesses to get started. The frequency of informal credit arrangements was highlighted (8 percent of total start-up credits). Regarding the source of financing for equipment currently in use, we observed the highest contribution of institutional resources (bank and cooperative, suppliers, public funds). Thus, institutional resources have a significant importance in Cuenca. It is interesting also to compare this latter observation with the level of fulfillment of the tax laws, which in Cuenca is the lowest of all three cities, particularly so when it comes to consider the simultaneous fulfillment of such commitments. Perhaps this explains in part why in this city the lowest levels of attachment to the promotion laws and schemes aimed at the microenterprise are recorded, which is in open contradiction with the denomination usually given to Cuenca as "Ecuador's artisan center" by public sector officials. Finally, it is in this city where the absence of some sort of accountancy system is most frequently noted. All these features help to rate the Cuenca-

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based enterprises as showing a less modern and entrepreneurial approach, in open contrast with Ambato. This takes us to a more general remark concerning the implicit criteria used in the distribution of the sampling by cities: we had assumed that the enterprises based in the capital city would show a different performance than those located in the secondary cities; it did not always work out that way. Furthermore, it can be said that indications of entrepreneurial ways and means do not always prevail in Quito (most of the time this is the case with Ambato), and on the other hand the state of affairs found outside of the capital city do not resemble those inside. In other words, each city shows specific peculiarities, which are necessarily related to their political status or population size. One analysis of economic sectors shows that the food processing sector is subject to the highest level of regulations (81 percent are regulated, of which 69 percent are subject to hygienic regulations). A large percentage of the entrepreneurs in this sector own the properties from which they operate, which goes some way to demonstrate enterprise purchase as a way to get started in the business. These initial purchases were partially financed with personal savings, but there exists a relatively high incidence of bank credits. The food processing sector is the most active when considering the purchase of additional equipment (in the period 1989-1992), but it has the lowest levels of attachment to any promotion law or scheme aimed at the microenterprise and trade union affiliation. The garment sector showed the fewest family links among the work force; thus wage earners prevail, despite the fact that this is the sector showing the largest number of own-account enterprises. The stability of the work force is higher than in the other sectors, and this activity shows a largest numerical increase. It must be pointed out, though, that this sector presents a relatively low level of equipment expansion since 1989. We have commented on the importance of institutional financing for the equipment currently held, and the high level of banking arrangements for the present year. However, on the minus side we must mention that this sector has the worst level of fulfillment of RUC, income tax, VAT (particularly so in the enterprises with more than ten workers), and municipal license commitments. Also, this sector has—despite its high level of tax evasion—the best level of attachment to the promotion laws and schemes aimed at supporting the microenterprise and contracting with the state. The repair services sector is noted for the male predominance in the work force and the remarkable rotation of this work force, showing a decrease in employment. But this sector of activity also shows the largest rate of labor affiliation. The repair services suppliers are mainly retailers and the clients are individuals. This is the sector of activity receiving less supplier credits and also granting less credits to their clientele. Personal financing (savings) to

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initiate the business and also to purchase the current equipment is important in this sector. Repair services microenterprises show the highest level of fulfillment of RUC and income tax, with VAT and municipal license at an intermediate level. This sector has a record of the highest frequency of trade membership. Account management systems are less frequent in this sector.

Final Considerations In this section, we shall produce some ideas and considerations on the impact of the institutional requirements on the enterprises in Ecuador, as well as some of their analytical implications. In enterprises with up to ten workers, the various fulfillment levels of these institutional requirements is shown in Table 16.1.

Table 16.1

Fulfillment Levels of Institutional Requirements for Enterprises of up to Ten Workers

Requirement

Fulfillment Level

Payment of minimum wage only Income tax Municipal license Value-added tax RUC Technical regulations Payment of overtime only Fulfillment to I E S S affiliation only Total fulfillment of labor laws 3

93% 82% 75% 72% 69% 50% 50% 35% 18%

fulfillment are taxpayers or are legally exempted are taxpayers or are exempted are taxpayers or are legally exempted holders observation rate observation rate meet this commitment fulfillment of the three labor laws

a. Affiliation with social security, adherence to forty working hours per week, and payment of no less than the minimum wage related to the legal duration of the working shift.

It must be pointed out that fulfillment rate of the requirements other than labor is in the region of 50 percent and upwards, whereas the labor laws' equivalent rate ranges from 50 percent down to 18 percent; payment of minimum wage (SMV) is an exception, with a very high fulfillment rate. However, the current purchasing power of this minimum wage is so low that there must be, out of necessity for the wage earners, a higher real income to ensure the workers can reproduce their labor capacity. The SMV has gotten to a point where it has been turned into a unit of measurement (as a reference to levels of pay), rather than a wage scale in the real sense of the word. We can say that the low level of the S M V makes its fulfillment a lightweight commitment for the employer. But, of course, we are not going to delete it

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from the list because it is clear that most of the labor requirements have a lower fulfillment level than other type of commitments. We can see also that the assortment of rates of fulfillment (ranging from 82 percent to 18 percent) does not allow for a purely dualistic viewpoint on informality, if we are to define formality as related to the fulfillment on the institutional requirements. Being unable for the time being to go further into measuring the different degrees of informality (with the distribution of the corresponding enterprises), it comes out as obvious that we have more than one set with fulfillment levels that overlap. Considering a gradual continuation from total informality to total formality, only a handful of enterprises would be placed in the extreme positions, 1 while most of them would be in intermediate levels of informality 2 within a wide spectrum. Furthermore, the administrative and legal requirements have a limited impact on the internal operation of the microenterprises: the legal parameter appears to have a very weak influence in the economic dynamism of those enterprises. The type and level of fulfillment of the requirements has no significant influence on the economic course of the enterprises. (We must remember here the two urban cases detected in Ambato and Cuenca and also the case of the garment sector, which allow us to infer that the level of fulfillment has no univocal relation to access to institutional financing or to public support.) This is to say that those requirements are more administrative and formal than tools of public economic policy. Fulfillment refers to the existence of a series of fairly close links with the various public and municipal administration teams 3 and the commitments separately produced by each one. Due to this, the small artisans and entrepreneurs, when faced with the institutional requirements, are going to think about these as having little positive effect for the enterprise together with little negative impact. From this we can see that the institutional framework is not going to induce, for this stratum of small enterprises, a permanent strategy of concealment and runaway attitudes. They would merely ignore and/or fulfill (depending on the case) the various regulations. We consider it more appropriate to say that the answers to the series of problems experienced in the relationship of the microenterprises and the corresponding legal/institutional framework are to be found not within the enterprises but with the state administrative setup. Indeed, as we have said, the former are optimizing their performance while adopting a passive attitude when confronted with the legal requirements (neither rejection nor active concealment). There are two approaches on logics that must be distinguished in what is concerned with the laws and bylaws of the state: (1) their conception and formulation, and (2) their implementation. The first entails the set of laws and regulations issued from various sources and levels within the public sector. The second refers to the production and enforcement of the law. These

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t w o l o g i c s c a n — a n d s h o u l d — b e analyzed separately because legal production has its o w n dynamism, whereas administrative enforcement f o l l o w s another pattern o f logic. It is this lack o f coordination that, in our v i e w , is g o i n g to c l a r i f y the relationship between the small enterprises and their corresponding legal f r a m e w o r k . D e Soto ( 1 9 8 6 ) has stated that incongruity o f law with its incidence w i l l explain evasion, and, furthermore, the l o w e c o n o m i c performance o f small enterprises, thus encouraging an informal sector. This, no doubt, happens in some cases. H o w e v e r , at least in the Ecuadorian context already r e v i e w e d , what prevails is a sort o f state absence 4 in what is concerned with the enforcement and control o f the law. In other words, the existence o f a vast l e g i s l a t i o n — w h i c h is in line with our juridical tradition in all f i e l d s — i s in open contrast to the mechanisms designed f o r their enforcement. T o this must be added the role o f the public o f f i c e r s in charge o f the inspection and control work. T h e survey detected almost no cases o f extortion or blackmail exercised by these o f f i c e r s onto the microenterprises that had evasion practices. T h e attitude shown by these o f f i c e r s was very tolerant, and the handling o f c o e r c i v e aspects was duly channeled in administrative procedures. This o f f i c i a l attitude when dealing with this set o f e c o n o m i c activities can also be understood if w e bear in mind that the possibilities o f getting m o n e y out o f these sectors is very limited; thus these initiatives, if any, are to be aimed at the m o r e sound enterprises. Trade associations act as intermediary concerns between the state and microenterprises. This fact, very much linked to the attachment to some o f the promotion laws (aimed mainly at the artisans) merits special mention, particularly the high levels o f tax f u l f i l l m e n t among association members, as membership introduces a series o f exemptions and s i m p l i f i e d procedures in the administrative formalities to be observed. It looks as though the vast amounts o f regulation, already referred to, call f o r c o l l e c t i v e and organized contacts with the state in order to obtain a n e w set o f s i m p l i f i e d and more general bylaws. In this w a y the levels o f informality (as w e understand it) have a close relationship with membership in a trade association. A microenterprise that is not affiliated with any trade association is c o m p e l l e d to abide by the universal and c o m m o n regulations (usually m o r e c o m p l e x and d i f f i cult to bear) and b e c o m e s m o r e vulnerable to possible controls. Thus trade membership becomes a necessary variable to be borne in mind in the analysis o f prevailing difficulties. Finally, what implications at a p o l i c y l e v e l could be mentioned when based on an analysis o f the operational relationship o f the microenterprises and the institutional laws? This is, no doubt, a question with no simple answers, but at least it deserves some comments. Taking due account o f what has been stated, it appears that a s i m p l i f i e d legislation, sensible as it could be, w o u l d have little impact at the l e v e l o f e c o n o m i c dynamism o f the enterprises under review. This is precisely the

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case: the development problems confronted by small-scale enterprises are not mainly due to these legal or institutional aspects, but with the general economic trends and the capacity of the state to generate specific support schemes (a fact we are all know too well). Thus, in the same way we see the contract between the legal production and its enforcement (in their regulation aspects), we see a contrast with respect to support policies: wordswollen juridical frameworks focused on the need to promote these activities, and comprising financial institutions and tailor-made support programs to channel public help. But on the other hand there are financial, technical, and operational inabilities preventing the state from implementing these proposals. The absence of the state is twofold: it does not assist, but it also does not hinder the operation of these activities (at least not at considerable levels). In any case, this promotional legislation has been focused almost exclusively on initiatives aimed at the improvement of the supply capabilities of these enterprises, disregarding the condition of the market where these microenterprises must sell their produce and supply their services. As regards this angle, and as far as the state demand is concerned (giving priority to purchases and using services supplied by these enterprises), it could, with better coherence, achieve a greater importance than what has been detected so far.

Notes 1. Despite the fact that 5 2 percent of the enterprises with up to ten workers state their fulfillment of the four tax requirements ( R U C , VAT, i n c o m e tax, and municipal license). 2. Stating again that w e are talking about informality in relation to the fulfillment of the institutional regulations. 3. It is worth making a difference b e t w e e n the state and municipal levels because it is obvious that they can be different. In other words, if w e note that the state level always appears to have little impact, the municipal level can exercise a variable pressure in line with the decision of the municipal authorities. 4. A b s e n c e that is in open contradiction to its bureaucratic size.

PART 4 Out of the Shadows: The Institutional Framework and Small-Scale Manufacturing Enterprises in Jamaica Patricia Anderson

Introduction to Part 4 Although the last two decades have seen an increased interest in the informal sector in most developing countries, this sector has long been the concern of development theorists and policymakers in the Caribbean. Starting with the work of Sir Arthur Lewis in the early 1950s, the small-scale sector was accorded a pivotal role in facilitating growth by releasing a supply o f cheap labor to the modern sector. This dual-economy perspective elaborated by Lewis ( 1 9 5 4 ) laid the basis for policies of "industrialization by invitation," which were pursued in Jamaica during the 1960s and gave expression to a generally optimistic view of the potential for modernization in the entire economy. Significant in this perspective was the belief that the traditional, or "backward," sector would eventually disappear or itself become modernized. The actual experience of this decade showed that although government policies that encouraged external capital investment could serve to expand production in the modern sector, they did not bring the anticipated benefits in terms of employment generation (Jefferson, 1972) or improved technological advance for the whole economy. The fragility of this pattern of development also became evident during the crisis of the 1970s, and in the ensuing period of protracted structural adjustment (Anderson and Witter, 1994). In addition, the expansion of the small-scale sector and the forced contraction of public sector employment led to a positive reappraisal of the potential of this sector to absorb labor and to alleviate poverty. In contrast to earlier approaches, the small-scale sector was no longer expected to disappear. Instead, attention was directed toward identifying the areas where formalization was considered desirable. These areas centered around the need

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to reduce open competition between large- and small-scale operators, to improve product quality, and to widen the tax net. Buttressed by the support of international agencies, the government of Jamaica has been seeking to develop a policy framework to address problems of microenterprise access to credit, marketing, and training. These are the three critical bottlenecks usually encountered in the small-scale sector. Given these concerns, much of the research on the Jamaican small-scale sector since the ned of the 1970s has been empirical in nature, with the primary concern being to establish the characteristics of the sector, to identify constraints to growth, and to examine the extent of linkages with the formal sector (PREALC, 1978; Fisseha and Davies, 1979; STATIN, 1984; Hamilton and Associates, 1989). The earliest attempts to explicitly address the relationship between the institutional framework and small-scale enterprises were motivated not primarily by the concern with policy formulation, but by an interest in identifying the distinguishing characteristics of the informal sector (Witter and Kirton, 1990; Anderson, 1987). The definition of informal activity proposed by Witter and Kirton (p. 2) specified that "an activity is said to be informal if it violates some law, official regulation or generally accepted standards and/or codes of business behaviour." The authors held that there was nothing inherent in an activity that made it informal, and that it depended on violation of the sociolegal framework of the economy, they also argued strongly against the popular conception that informal activities were necessarily small-scale, as this would exclude the wide range of illegal activities that fell within the ambit of the informal economy. The analytic framework for distinguishing informality was approached quite differently by Anderson, who focused on the incorporation of standardized modes of production as one of the critical steps in formalization, in addition to universalistic worker-management relations. From this perspective, the informal sector was said to be characterized by the small-scale delivery of a variable good or service within the context of particularistic relationships (Anderson, 1987). More recent studies have sought to explore the thesis popularized by de Soto (1989) that informality is the response of the small-scale sector to the high costs imposed by a burdensome and inefficient regulatory system (McBain et al„ 1994). On the basis of a study of urban firms employing thirty or fewer workers, McBain et al. estimated that a quarter of all firms were not registered. They concluded that for small firms, the costs of acquiring and maintaining legal status tended to outweigh the benefits, and that the incentive to become formalized existed mainly for those firms who wished to enter the export market. For this group, they recommended the rationalization of registration and tax compliance procedures, as well as support in terms of legal and accounting services. This would allow them to acquire formal status and so benefit from lower import duties and export incentives.

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The present study is an attempt to undertake a systematic examination of the impact of the institutional framework on the operations of the smallscale sector within Jamaica, and to explore the perspective of small-scale entrepreneurs on the costs and benefits of regulation. It is guided by the work of the ILO, which specifies three different aspects of legality: business registration, taxation, and labor protection, and which also distinguishes between legal recognition and the actual observance of legal obligations (Tokman, 1992). The study found that for small enterprises in Jamaica, the process of becoming part of the formal system of business regulation is a trade-off between the benefits of increased visibility and the deflection of resources and income to meet official requirements. This movement out of the shadows may be voluntary or involuntary. As a voluntary decision, it may reflect either the professional aspirations or the ethical convictions of the small business operator. It may also result simply from a reasoned judgment that, on balance, "it's better to be legal." On the other hand, the involuntary observation of regulations may be the consequence of more effective policing by tax collectors and other inspectors seeking to widen their nets and to force an unruly small-scale sector into some measure of compliance. From this study of small-scale manufacturing in Jamaica, it became apparent that compliance levels increase with the size and the visibility of the firm, but decrease with distance from the urban center. It was clear that at the level of the microenterprise, the institutional system is neither monolithic nor interlocking, so that compliance varies with both the particular regulation and the nature of the productive activity. This may be appreciated from our finding that, in general, health regulations receive fairly wide support, perhaps because their violation tends to have an early impact on the activities and reputation of the business. On the other hand, safety regulations pass unnoticed, or are observed at their bare minimum. Similarly, the minimum wage may establish a floor for worker compensation in some firms, whereas in others the irregular flow of business activity is the basis for an understanding that worker incomes must also ebb and flow with the bad and the good times. In such cases, the recognition of basic survival needs leads to more fluid work relationships, which combine wage work with self-employment, or which provide nonwage benefits. To facilitate this, workers may be allowed to supplement their unstable incomes under the umbrella of the firm through the use of business equipment and facilities for small personal jobs. This is accompanied by an understanding that, in turn, workers make themselves available in times of labor demand. Tax regulations met the lowest level of compliance; nonetheless, it was found that compliance became an arrangement that was regarded as negotiable by small operators. In general, therefore, our study arrived at a conclusion similar to that of Tokman (1992), namely, that the informal sector operates in a gray area between underground and legality; in this way, the

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informal gains gets access to what is considered important while minimizing the risks associated with illegality. It should also be acknowledged that some of the observed variation in compliance may be explained by the degree of congruence between official requirements and underlying cultural norms regarding social justice within economic transactions. These unwritten rules serve to define what it is reasonable to demand and to expect within the domain of work and the market, given the level of activity of the enterprise and what is perceived as the limited contribution of the government to the success of the firm. Because small size also entails a greater degree of transparency, the expectations of workers with regard to compensation will vary with their assessment of the firm's success. In such cases, the sense of being treated fairly or unfairly may hinge more around assessments of what is possible rather than the employer's compliance with minimum wage and other labor protection guidelines. These assessments are ultimately of significance in that they determine the amount of effort workers consider reasonable to expend, as well as the degree to which workers feel justified in reimbursing themselves through appropriation of the firm's goods. In view of the popularity of the de Soto (1989) thesis in the recent literature on the informal sector, it may have been expected that Jamaican microenterprises would indicate that they were fleeing formalization because of the high transactional costs entailed in becoming legalized. Although this may prove to be true for firms operating at a larger scale than the microenterprise level, there was little evidence that for the small businesses in our survey, namely those with fewer than ten paid workers, bureaucratic costs were a major deterrent to compliance. In contrast, formalization was generally viewed as not realistic at this point in time, but appropriate for a later stage of business development. Such steps could reasonably be considered when the business had achieved an income level that was sufficiently high and stable, and when the visibility that was required for the maintenance of this income made evasion impossible. The objective of the study was to examine the behavior of microenterprises in regard to their participation in the market for goods and services, capital and labor, and to obtain an assessment of the extent to which they observed or circumvented the official regulations governing these activities. The methodology of the study is presented in Part 1. Chapter 17 outlines the main features of the legal and regulatory system, particularly with regard to those productive activities that are not directed at the export market. These include regulations for business registration, taxation, health and safety, quality control, and labor compensation and protection. Chapter 18 elaborates on the characteristics of the firms in the sample and of the entrepreneurs, Chapter 19 focuses on the behavior of microentrepreneurs with regard to the regulatory framework. The final chapter summarizes the outlook for the small-scale sector, the constraints for growth, and the implications for the national system of business regulation.

PART 4: JAMAICA

17 The Legal and Regulatory Framework for Small Business

T h e regulations that relate most closely to the operations o f small enterprises in J a m a i c a are those that specify the guidelines for business registration, taxation, health and safety, and labor compensation and security. T h e s e are described briefly in this chapter.

Business Registration F o r a small business in J a m a i c a , the first point o f entry into the official count o f documented business may occur either at the level o f business registration with the Registrar o f Companies, or through the acquisition o f a business enterprise number from the R e v e n u e Department. This entry point will depend on whether the business is conducted in the proprietor's name or under a distinct business name. In the latter case, the business must be registered with the Registrar o f Companies, and on the basis o f this application, a B u s i n e s s N a m e Registration Certificate is obtained. Company registration is a requirement for every firm that has a place o f business, is not a limited liability company, and is operating under a business name that does not consist o f the true surnames o f the operators. Application must be made not more than fourteen days after business has c o m m e n c e d , and registration is valid for a period o f three years. T h e fee for application is J $ 5 0 . T h e alternative entry point, and sometimes the second level o f registration for a small business is business enterprise registration through the R e v e n u e Board. T h e R e v e n u e B o a r d is a department in the Ministry o f Finance, which reports directly to the Minister, in contrast to the I n c o m e Tax Department, which reports through the financial secretary. T h e law requires registration for all persons engaged in business, as well as all companies, partnerships, sole proprietors, government departments, and organizations engaged in business activity. F o r the typical microenterprise, which is likely to be operated by a sole proprietor not using any business name and not

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registered with the Registrar of Companies, Revenue Board registration requires that an income tax number and a national insurance number be furnished. Each enterprise is assigned a unique number, the Business Enterprise number, popularly known as the BENO. This number becomes a requirement for successive stages of formalization, such as the application for a tax compliance certificate or registration for the general consumption tax.

Taxation There are three types of tax liability to which a small entrepreneur may be subject in Jamaica. These are income tax, business profits tax, and the general consumption tax. Income Tax Personal income tax liability exists for those persons who earn more than J$ 14,000 (US$1 = J$22.4, approximately) annually. The rate is one-third of total earnings, and to this is added the education tax of 2 percent. Although National Housing Trust deductions come to an additional 2 percent, this deduction is a refundable contribution if the contributor does not obtain benefits directly in the form of mortgage or housing cost assistance. Business Profits Tax Business taxes are assessed by the Revenue Board on small businesses that are not already registered as companies. Firms are often added to the list through surveillance activities of the Board. In such cases, the revenue officers visit the enterprise and make an assessment of the level of profit and related tax liability. The firm is then advised in writing. At this point the operator may object to the assessment, and if necessary may enlist an accountant to prepare some form of written accounts on which the tax assessment may be contested. The tax rate on companies is one-third of profits. General Consumption

Tax

The general consumption tax is a sales tax, implemented in October 1991, which is administered by a special department within the Ministry of Finance. The tax is a value-added tax that replaces, by combining under one umbrella, several other consumption taxes such as retail sales tax, excise duty, selected stamp duties, and so forth. The law requires most businesses to register and to charge and collect a tax of 10 percent on all the standard-

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rated goods and services that they supply, and in turn to remit these monies to the collector of taxes (Inland Revenue Department) by the end of each taxable period. There are selected items that are exempt from G C T payment, and the threshold for tax liability for small firms is a gross turnover of J$ 12,000 monthly, or J$ 144,000 annually. Below this level, small firms are not required to collect the GCT, although they have the option to do so under the category of voluntary registration. Those very small firms that fall below the level of GCT liability are required to be listed as a registered person, and failure to do so also involves a fine. The purpose of this registration is to allow the G C T Department to maintain a register of small enterprises that should be monitored for future eligibility. The law requires that G C T registration be undertaken within twentyone days of starting a taxable activity, and the submission of an application entails the prior possession of a Business Enterprise number. It is also the practice of the Revenue Board to supply the GCT Department with the names of businesses that have acquired a BENO, for future follow-up. For those firms classified as registered taxpayers, the failure to submit G C T payments at the end of each taxable period entails the risk of a fine of 30 percent of the tax assessed as due for that period. The benefits of G C T registration include the ability to claim input tax credits and inventory credits, so it may be in the interests of small firms to become voluntary taxpayers even if they fall below the threshold. However, the amount of paperwork involved in all of this accounting may exceed the capabilities of most of these enterprises.

Health and Safety A complex of health and safety regulations apply to manufacturing activities, and are administered by three separate departments: (1) the Factory Inspectorate within the Ministry of Labor, Welfare and Sports, (2) the Public Health Department within the Ministry of Health, and (3) the Bureau of Standards within the Ministry of Industry and Commerce. Factory

Inspectorate

The Factories Act requires employers operating factories to put into place specific safety, health, and welfare provisions. These provisions detail the safety precautions to be implemented with regard to machinery, electrical apparatus, and equipment such as ladders, ropes, and chains. Emergency exits are to be maintained, and suitable sanitary conveniences must be provided for workers. The law also specifies the minimum space to be allocated for every worker, as well as requirements for effective lighting and room

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temperature. Under the law, reports should also be made to the Factory Inspectorate regarding accidents, fires and explosions, and industrial diseases. The Factory Inspectorate is responsible for inspection, and has the power of prosecution for noncompliance. Plans for new factories must be approved by the chief factory inspector, who is usually the permanent secretary. There is no minimum employment size in the definition of a factory, and enterprises engaged in repairs are also classified as factories for this purpose.

Public Health Department The Public Health Department within the Ministry of Health exercises responsibility with regard to monitoring the sanitation of all enterprises engaged in food preparation and food processing. Under the Public Health Law, inspectors make routine checks of food manufacturing establishments and restaurants, and in the course of these visits point out health hazards to proprietors. They are also empowered to prosecute in the event that warnings are not observed. Other specific responsibilities of this department are the issuing of food handler's permits to all staff engaged in the food industry, as well as the inspection of meat. The procedure for obtaining a food handler's permit entails attendance at the government's Food Handler's Clinic, at which screening tests are conducted. Although the regulations include a blood test, stool analysis, chest X-ray, and nose and throat swabs, financial constraints usually limit these examinations to the blood test only. There is a small charge of J $ 1 4 for the service. On completion of the test, the applicant undergoes an interview with the public health inspector in order to screen for venereal disease, typhoid, and other diseases. The food handler's permit is valid for one year, and it is often demanded by prospective employers before considering new applicants. The responsibility for compliance therefore falls on the individual and not only on the firm.

Bureau of Standards Within the Bureau of Standards, the Food Inspectorate Division has the responsibility for monitoring the production o f all processed food. Certification by the Bureau of Standards is essential for firms seeking to export their products, and involves a stringent set of tests in the case of certain prescribed foods. Even where batch testing is not required, the bureau issues guidelines for sanitation and quality control, and the observance of these guidelines is documented by inspectors. All of these tests and site visits involve a charge for the firm, so that very small food-processing firms are

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not likely to seek out Bureau of Standards certification, despite the prestige it may bring.

Labor Regulations Within Jamaica there is an extensive set of labor regulations to establish minimum levels of worker compensation, labor protection, and social security. The National Minimum Wage was established in 1974, and has been upgraded at regular intervals in order to offset some of the reduction in purchasing power due to rapid inflation. An increase took effect on July 6, 1992, establishing a minimum wage level of J$300 weekly for all categories of labor. This replaced the former level of J$ 160 minimum weekly for all workers, except domestic workers whose wage was J$ 140 weekly. In all cases, separate agreements are established for garment workers in the free zones. Although there is no specific regulation governing maximum hours of work, the Minimum Wage Law specifies hourly rates of pay and overtime rates, as well as a weekly rest day so that employers are not at liberty to extract extra hours of work for a fixed sum. Leave arrangements are specified by the Holidays with Pay Order, which governs both vacation leave and sick leave. This order applies to all categories of workers, with the amount of leave depending on length of service. Protection against arbitrary dismissal is afforded through the Employment (Termination and Redundancy Payments) Act, which was passed in 1974 and amended on different occasions. The act provides minimum standards for notice to be given on termination of employment, and allows the payment of wages in lieu of notice. Where employment is terminated because of redundancy, the Act sets out a schedule for compensatory payments. Whereas the above regulations are the particular responsibility of the Department of Labor, social security provisions for workers are part of the National Insurance Scheme (NIS). The National Insurance Scheme is a contributory scheme under which employers are required to deduct NIS payments for all workers regardless of the length of their employment. The monthly deduction for NIS is very small, and cannot exceed J$31.40 monthly. It is calculated as 2.5 percent of the monthly wage, up to a ceiling of J$ 1,256 monthly in earnings, and the deduction is matched by a contribution from the employer. The benefits include old-age pensions and death benefits, as well as injury and disability payments. In the case of private domestic workers, the NIS contribution is also linked to maternity leave benefits,

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which are borne by the government for this category o f workers only. The paperwork involved in maintaining these records is significant. Under the National Housing Trust program, workers' contributions are matched by employer contributions. However, whereas NIS contributions are negligible, the NHT deduction amounts to 2 percent of gross emoluments from workers, and 3 percent from employers. Despite the higher level of deduction that the NHT contribution entails, there is generally wide support for this program, as the benefit in terms of access to housing or to mortgages at preferred rates is significant.

PART 4:

JAMAICA

18 Operating Features of Small Manufacturing Enterprises

For the majority of enterprises in our sample, business activity was the cornerstone of their livelihood. Given the age of our sample firms (58 percent had been established before 1986), and the generally high failure rate experienced by small businesses in their first four years, our sample may be regarded largely as a population of survivors. This experience of having overcome many difficulties was reflected in the outlook of respondents, the majority of whom expressed their determination to stay with their businesses and, if possible, to expand. There are distinct differences in the profiles for each of our manufacturing sectors, as well as some amount of diversity within each group. This internal variation may be expected from the range of activities represented in some sectors. In general, it is possible to say that furniture making and equipment repairs included more of the newer entrants to the field, whereas firms engaged in garment making and food processing tended to be somewhat older on average. The majority of small garment-manufacturing firms were own-account home-based operations, whereas many furniture-making and equipment-repairing activities operated from private yards. In our sample, garages dominated as the place of business for equipment-repairing firms, which were less likely to occupy commercial buildings. Marked differences are evident among sectors in the scale of activity, based on the firm's estimate of the replacement value of its machinery and on its statement of maximum gross sales in a good month. Within the foodprocessing group, there was a wide span, ranging from the butcher who operated out of his own yard using limited equipment and had a relatively large cash flow, to the bakeries with high levels of investment in machinery. The same was true for the equipment-repair group, in which garages utilized higher levels of capital investment and employed larger numbers of workers and trainees than was found in many other activities. Despite these differences, the history of these small enterprises is remarkably similar. The large majority started out with their own savings,

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sometimes assisted by loans or gifts from family or friends, but with little access to formal credit. As they developed their businesses, they came to have closer links with commercial banks, but they still found that they were starved of access to capital and credit. L a c k of capital was identified as the main problem in their start-up period and remained a cause of serious difficulty. It is significant, however, that as these firms continued, demand problems began to assume importance. Many of our respondents attributed these difficulties to the dampening effects high inflation had on consumer spending, and on business activity in general, and to the fact that increases in raw material prices and utility costs were pricing their goods and services beyond the reach of many consumers. Inadequate market demand was cited most frequently as a problem by garment-manufacturing firms, and was also identified as a serious problem by all sectors. From the perspective of this study, it is of particular significance that legal and bureaucratic constraints were not frequently mentioned as a bottleneck either in business start-up or in continuing activity. This may be due in part to genuine ignorance or to deliberate disregard of official regulations, but it is also clear that most of these small firms are targeting local markets and clientele where their strength rests on the basis of their reputation. The garage operator on a side street in May Pen may not have been legally registered, and may not hang out a sign, but his success depended as much on word-of-mouth advertising as the "jerk chicken" seller for whom loyal customers make a detour from the main road. Even where official registration was required in order to secure particular jobs, respondents reported that they were able to circumvent this in several ways. From the perspective of the small operator, informal status represented a constraint mainly in regard to securing loans, but even in this case the high interest rates and lack of collateral were stated as the primary factors that stood in their way. Although employment size and capital investment are factors that serve to encourage firms to formalize activities, it was also observed that legal registration did not necessarily imply formalization of employment relations. The standardization of labor returns seemed to hinge more around the organization of work within the industry, the level and continuity of business activity, and whether there was a need to maintain a stable or a skilled work force. As a result, despite the higher investment levels of garages, the conditions of employment in this sector seemed to be defined mainly in terms of a "hustle." It was observed that "prentices" moved in and out of the industry, earning "a money" but with little prospects for upward mobility within the firm. On the other hand, within the small tailoring and dressmaking establishments, there was more rigid adherence to minimum wage guidelines within an environment flavored by greater "respectability," but with little opportunity for higher earnings. This chapter reviews some of the main features of the firms within our

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manufacturing sample, as well as the characteristics and attitudes of their owners. This description is based primarily on the findings from the national survey, but also draws on data from the case studies in order to amplify these findings. This serves as a background for the discussion of the relationships between microenterprises and the institutional framework, which follows in Chapter 19.

Social and Demographic Characteristics In addition to the gender differences in manufacturing activity, which have been discussed in Part 1, there are also marked differences in the age structure and educational attainment of entrepreneurs in different activity sectors. This is apparent from Table 18.1, which shows that in our sample, furniture makers tended to be the youngest group and food processors were the oldest. Nearly half (45 percent) of those in furniture making were below 35 years of age, in contrast to only 7 percent of those in food processing. The older age profile of the food processors may be related to the heavy representation of butchers and bakers in the sample, and raises the question of whether these may prove over time to be dying occupations, at least at the level of microenterprise activity. This also serves to explain some of the difficulties encountered by STATIN in obtaining the target number of small businesses in food processing. In the case of those operators in garment manufacturing and equipment repairs, there is a more balanced age distribution, suggesting that both are still vibrant production areas. The data on the educational attainment of business operators show that those who are engaged in equipment repair are most likely to have obtained a high school education or higher (26 percent), whereas garment manufacturers and furniture makers exhibit fairly high concentrations at the new secondary level. The lowest levels of formal education are reported by those in food processing (78 percent with only primary education), a pattern that is, of course, related to their older age distribution. It is important, however, to bear these differentials in mind when educational differences are noticed in the observance of regulations. Such variations may reflect differences in the organization of different activity sectors, rather than reflect some greater educational enlightenment on the part of entrepreneurs. Finally, data in Table 18.1 show that roughly half of all equipmentrepair and furniture-making firms have been established since 1985, in contrast to the more even distribution for food-processing firms. However, it is not possible to say whether the larger proportions of young firms are reflective of the fact that furniture making and equipment repair are more attractive to new entrepreneurs, or whether they have a higher failure rate so that older entrants are less likely to be remain within the ranks of the industry.

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Table 18.1

Social and Demographic Characteristics of Sample Entrepreneurs by Economic Activity (percentages) Economic Activity

Social and Demographic Characteristics

Garment Food Manufacture Processing (N = 56) (N = 55)

Furniture Making (N = 6 6 )

Equipment Repair (N = 66)

Total (N = 2 4 3 )

Gender Male Female

42.9 57.1

78.2 21.8

97.0 3.0

95.5 4.5

79.8 20.2

Age Under 35 years 35^14 years 4 5 - 5 4 years 55 and older

32.2 25.0 19.6 23.3

7.5 14.8 31.5 46.3

45.5 24.2 19.7 10.6

28.8 33.3 22.7 15.1

29.4 24.8 23.1 22.7

Education (highest level attained) Primary 44.6 New secondary 44.6 High school or higher 10.8

77.8 13.0 9.2

39.4 48.5 12.1

41.5 32.3 26.1

49.8 35.3 14.9

Year started activity Before 1970 1970-1979 1980-1985 1986-1992

25.5 25.5 25.5 23.6

4.7 21.9 20.3 53.1

10.8 16.9 23.1 49.2

14.6 22.2 21.3 41.8

20.0 25.5 16.4 38.2

N = Sample size.

Firm Origin and

Ownership

At this level o f operation, the majority o f all firms were started from scratch, whether in rural or urban parishes. This accounted for 9 4 percent o f businesses in Kingston and St. Andrew, and 9 0 percent in the rural parishes. F o o d processing and equipment repair were the sectors with the highest reports o f inherited firms, but these did not account for more than a tenth o f the total, even in rural areas. With regard to type o f ownership, the data indicate that roughly four-fifths o f all enterprises were sole proprietorships, and family businesses accounted for 11 percent. T h e firms most likely to be family concerns fell into the category o f food processing, in particular those that were operated by women. Partnerships accounted for 7 percent o f all enterprises, and these tended to be within the area o f equipment repair and furniture making. Given the small scale o f operation at which these firms started their activity, and their reliance on their own sources o f capital, it was not surprising to find that slightly less than a third ( 3 0 percent) operated from c o m mercial buildings. This was most likely to be the case for bakeries within the

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food-processing group, whereas garment-manufacture and furniture-making establishments often operated out of homes or premises that were also family residences.

Scale of Operations To obtain some measure of the scale of operations of these small firms apart from our stratifying variable of employment level, it is useful to examine the level of capital investment in machinery as well as the value of sales that firms indicated they are able to handle in a good month. This is shown in Tables 18.2 and 18.3. Not surprisingly, food processing and equipment repairs reported the highest replacement values for machinery. In food processing, 30 percent estimated the replacement value of their machinery at above J$ 100,000, whereas 27 percent of equipment repair fell into this category. The relative

Table 18.2

Estimated Replacement Value of Machinery by Economic Activity (percentages)

Estimated Replacement Value of machinery (J$)

All Firms

5,000 or less 5,001-10,000 10,001-20,000 20,001-50,000 50,001-100,000 More than 100,000

20.5 17.9 19.2 14.6 9.9 17.9

34.0 22.0 20.0 8.0 8.0 8.0

100.0 151

100.0 50

Totals Percent Number

Table 18.3

Garment Food Manufacture Processing

Equipment Repair

17.4 13.0 13.0 13.0 13.0 30.5

15.6 15.6 22.2 17.8 13.3 15.6

9.1 18.2 18.2 21.2 6.1 27.2

100.0 23

100.0 45

100.0 33

Highest Level of Monthly Sales by Economic Activity (percentages) Food Garment Manufacture Processing

Highest Level of Monthly Sales (J$)

All Firms

1,000 or less 1,001-3,000 3,001-5,000 5,001-10,000 10,001-20,000 20,001-500,000

9.2 20.1 17.8 25.9 14.9 12.1

26.3 31.6 23.7 11.1 0.0 5.3

100.0 174

100.0 38

Totals Percent Number

Furniture Making

Furniture Making

Equipment Repair

7.3 19.5 12.2 22.0 19.5 19.5

4.8 14.3 23.8 26.2 21.4 9.5

1.9 17.0 13.2 37.7 17.0 13.2

100.0 41

100.0 42

100.0 53

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ease of entry that exists in garment manufacture is evident from the low capital value of the machinery, as roughly a third (34 percent) of respondents estimated their replacement value at J$5,000 or less. Furniture making fell somewhere in the middle, with 22 percent of operators estimating their machinery to be valued between J$ 10,000 and J$20,000. It should also be borne in mind, however, that firms who have not made recent purchases may be severely underestimating their replacement values, given the drastic devaluation of the Jamaican dollar over the period 1991-1992. In terms of highest monthly sales, microenterprises engaged in garment manufacture again reported the most modest levels, as nearly three-fifths of the sample (58 percent) said that their highest monthly sales did not go above J$3,000. At the upper end, food-processing firms again reported the highest levels, as 20 percent said that, in their best months, their total sales were above J$20,000. The internal variation within this group should not be overlooked, however, as Table 18.3 makes clear that within food processing, there were also many low producers, whose sales fell below the J$3,000 mark. Urban parishes were most likely to be the base for firms that reported high monthly sales levels, and these also tended to have a larger work force (Table 18.4). Among the Kingston and St. Andrew firms, a quarter (26 percent) reported sales above J$20,000 during their best months in contrast to less than a tenth of rural-based firms. Similarly, 35 percent of all firms that employed between five and nine workers reported the highest level of sales capacity, compared with 12 percent of those with one to four workers. The relationship between this measure of scale and the willingness to observe regulations is explored in the following section.

Table 18.4

Highest Level of Monthly Sales by Employment Size of Firm and Geographic Location (percentages) Size of Enterprise (number of people) Geographic Location

Highest Level of Monthly Sales (J$) 1,000 or less 1,001-3,000 3,001-5,000 5,001-10,000 10,001-20,000 20,001-50,000 Totals Percent Number

Own-account Firms

2-5

6-10

Kingston and Rural St. Andrew Parishes

25.5 39.2 21.6 9.8 2.0 2.0

3.0 14.1 15.2 33.3 22.2 12.1

0.0 0.0 15.0 35.0 15.0 35.0

3.7 22.2 11.1 18.5 18.5 25.9

10.2 19.7 19.0 27.2 14.3 9.5

100.0 51

100.0 99

100.0 20

100.0 27

100.0 147

Note: The strata of employment size of 2 - 5 means the owner plus 1 - 4 workers; the strata 6 - 1 0 means the owner plus 5 - 9 workers.

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Supply and Demand Linkages The dilemma that faced the small manufacturing firms in our sample was twofold. In the first place, they were heavily dependent on retailers and wholesalers for raw materials and supplies, and accordingly were subject to escalating input prices as a result of both devaluation and high dealer markup levels. Second, because they served small local markets, they could not attempt to pass on the full weight of these price increases to their consumers without eroding their own base. As a result, many operated with unutilized capacity, and, perhaps somewhat mistakenly, attributed their problems to be lack of demand. The second contradiction that undermined these small businesses was the extent to which they were unable to mobilize working capital, both because of inadequate support from formal institutions and because they were forced to extend credit to customers without being able to enjoy the same breathing space in relation to their suppliers. Without the benefit of formal accounts, it is possible that many small producers may not have been fully aware of the extent to which their own working capital was tied up in "bad bills" or in providing involuntary credit to their customers. Because they were tied to a limited geographic area and to local clientele, the handling of these relationships with their customers required a fairly personalized approach so that they were caught in a continuing squeeze of shortage of working capital and the inability to stockpile against price inflation. These difficulties were clearly identified by respondents in their statement of current business problems and are discussed below. The dependence of manufacturers on retailers, wholesalers, and large industrial enterprises for their supplies was also analyzed. Retailers were the supply source for 54 percent of the sample, and wholesalers were cited by 38 percent. In addition, 17 percent said that they bought their inputs directly from large producers; this group included mainly those in equipment repair. The firms that had backward linkages with agricultural sources of supply were primarily those in food processing and furniture making, and this proportion stood at 16.5 percent for the entire sample. According to the producers, the only other alternative to the problem of inadequate working capital was to have their customers provide some of the inputs, as was the case for garment manufacture, furniture making, and equipment repair. For the sample as a whole, this proportion represented 28 percent, but was 64 percent for garment manufacture, 29 percent for furniture making, and 20 percent for equipment repair. When asked whether they had any problems with their supplies, 56 percent said that they had no complaints. Food processors were most likely to be satisfied with their situation (69 percent), and equipment-repair firms were least satisfied (42 percent). The responses of these firms made it clear that their difficulties stemmed primarily from the cost of these inputs, par-

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ticularly in the case of furniture making and equipment repair. Furniture makers tended to complain of poor-quality supplies, whereas equipmentrepair firms complained of availability. On the demand side, one-fifth of all the sample firms admitted that they had difficulties finding enough customers, and 41 percent said that they could expand their output, given their present resources. Food-processing firms were the least likely to state that they had problems finding customers, but, in common with the other activities, they also said that they had the capacity to expand output. In this regard, among the ninety-seven firms in the sample who said that they could expand their output, 23 percent said that they could double their current production level. An equal proportion said that they could expand by another 50 percent, and 12 percent of the sample said that a 30-percent expansion was possible. In addition, 7 percent said that their unutilized capacity could allow them to expand by 20 percent. The market at which these small firms directed their sales consisted heavily of private individuals. Only 7 percent said that they supplied retailers, and 3 percent counted government departments among their customers. This should not be taken to mean that only this tiny proportion of our sample has ever received government contracts because, as Table 18.5 indicates, 8 percent report having received a government contract at some point. As may be expected, larger firms have had more experience in handling orders and contracts, and in particular have participated in government contracts. The explanations firms provided as to why they have never carried out work for the government centered primarily around lack of interest, lack of information, and their perception that they needed to have political connections or support to obtain such contracts. There was less concern about

Table 18.5

Firms Receiving Orders and Government Contracts by Economic Activity, Employment Size, and Location (percentages) Receive Orders or Contracts

Have Obtained Government Contracts

Economic activity Garment manufacture Food processing Furniture making Equipment repair

17.9 12.7 25.8 19.7

7.1 3.6 9.1 12.1

Employment size Own-account 2-5 6-10

13.8 17.8 40.0

1.3 10.9 16.7

Geographic location Kingston and St. Andrew Rural parishes

32.1 15.8

9.4 7.9

All firms

19.3

8.2

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difficulties in meeting administrative requirements, although some said that their firms could not handle orders that large.

Capital Credit and Constraints In order to find the capital to get their business established, the majority of our sample entrepreneurs had to rely on their own savings or on assistance from their personal networks of family and friends. Indeed, 68 percent of business operators drew on their own savings, with an additional 5 percent calling on savings from overseas employment. Friends and family provided start-up assistance to nearly one-fifth (18 percent) of all proprietors, and formal lending agencies assisted less than one-tenth of the sample. The limited role played by lending agencies should be set against the proportions of entrepreneurs who stated that they had tried to obtain a startup loan from this source (Table 18.6). One-fifth of these small business operators said they had in fact tried to obtain formal assistance, with the proportions ranging from 13 percent of food-processing firms to 30 percent of those in equipment repair. Among the 170 respondents who had not tried to obtain a bank loan, the major reasons given were no need for additional funds (29 percent), a dislike of borrowing money (17 percent), lack of collateral (32 percent), inability to deal with the high interest rate (28 percent), and not being able to provide the required documents. An additional 6 percent said that at the time they did not know how to proceed in applying for a loan. Despite the lack of support given by commercial banks in their start-up period, a large proportion of business operators went on to establish relations with commercial banks once their business was under way. This is also shown in Table 18.6, which indicates that 45 percent of the sample entrepreneurs said that they now had regular dealings with banks. It is also clear that firms operating on a larger scale are more likely to have proceeded with this level of formalization, and thus own-account operators are less likely to have established banks in contrast to firms with paid workers. The inability of these enterprises to call on the commercial banking system for working capital compounds the problems of cash shortages, which they already have. Liquidity problems arise because small enterprises do not receive very much credit from their suppliers, but in turn they find themselves required to wait for customers to settle bills. Table 18.7 reveals this basic asymmetry in credit relations, as only 4 percent of all respondents said that they enjoyed flexible payment arrangements with their suppliers, but 18 percent said that they had unspecified time payments with their clients. If comparisons are made on the basis of the traditional thirty-day credit limit, the same observation holds true. Suppliers were said to give thirty days of credit to 10 percent of the sample, whereas 18 percent said that they allowed their own customers thirty days' grace.

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