Article: Tuesday, 7 February 2023

Are there any strategic advantages for start-ups to operate ‘under the radar’ of government? All around the world, start-up businesesses get underway in the informal economy without registering with the authorities, particularly where there’s widespread poverty. Do these conditions make it more likely that these businesses will export? Dr Caroline Witte, assistant professor in the department of Strategic Management and Entrepreneurship at Rotterdam School of Management, Erasmus University (RSM) wanted to find out if start-ups in the informal economy that registered with the authorities only later are more likely to export than businesses that registered as soon as they were founded.

Dr Witte worked with Prof. Marcus Larsen of Copenhagen Business School, and their findings are described in their paper Informal Legacy and Exporting Among Sub-Saharan African Firms published in the journal Organization Science.

The trend is for more formality but…

There’s a trend in international policy initiatives toward formalising informal businesses – but is that best for the developing new businesses? Or does it stifle their attempts at entrepreneurship and their chances of developing into successful exporters?

There's plenty of debate about whether or not registering and doing things by the book affects the performance of start-up businesses. Dr Witte’s research aims to better understand the benefits of operating under the radar of government at the start-up phase – in other words, how businesses grow best when formal institutional conditions do not necessarily support their growth.

Using the flexibility of informality

You might associate businesses operating informally with lower productivity – and you might think they have less legitimacy – but the researchers wondered if in fact these businesses might be using their time to explore their markets, experiment, and make the most of the flexibility that informality gives them. The researchers wanted to find out if this was true and if, when these businesses later formally register, they eventually seek foreign markets and make a success of exporting.

Dr Witte analysed the relationship between ‘starting out informally’ and exporting in 7,223 firms across 27 Sub-Saharan African countries. The African continent provides a unique context to study the effects of informality. Dr Witte is careful to point out that while the vast informal economy in Sub-Saharan Africa is largely deprived of decent working conditions and therefore should not be romanticised, it does offer a valuable theoretical context in which to investigate how firms explore and experiment in less constrained environments.

The study of start-up businesses in Sub-Saharan Africa did indeed show that firms that started their operations in the informal economy and registered later are more likely to initiate exporting than firms that were launched as formal enterprises. This suggests that firms without access to an efficient market can use informal operations to grow and build competitive advantage.

When informal beginnings have a positive effect

The researchers’ exploratory analysis showed that in countries where institutions are distrusted, operating informally for a short period of time before registering has a significant positive effect on the probablility of exporting. But in countries with strong, trusted institutions, informal beginnings do not have an effect on the likelihood of a start-up doing export business.

Are the official development policies wrong?

The informal economy constitutes the lion’s share of many low- and middle-income economies, and there are several official development policies directed at formalising it.

Both the United Nations’ Sustainable Development Goals and the International Labor Organization’s ‘Decent Work’ campaign see formalising economies as central to achieving sustainable development and improving working conditions of people in the informal economy. Yet Dr Witte’s research suggests that experience of operating informally in their start-up stages may stimulate businesses to expand after they become formalised. Exporting is viewed as highly desirable in most developing and emerging economies.

Dr Witte suggests there is a need to better understand how policies can cater to firms that operate in an informal context and use it as a platform for further business development, instead of seeking to eliminate informal operations. Particularly in countries where institutional trust is low, this might encourage firm development more than policies that aim to eliminate informal operations , particularly for African firms.

Dr C.T. (Caroline) Witte
Assistant Professor
Rotterdam School of Management (RSM)
Erasmus University Rotterdam
Caroline Witte

Prof. Marcus Larsen

Professor for Department of Strategy and Innovation

Copenhagen Business School (CBS)

Profile picture of Professor Marcus Moller Larsen
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