Informal SME in Lao PDR
Many businesses in Lao PDR remain informal, and struggle to grow into medium-sized and large businesses that are capable of providing decent work for large numbers of Lao PDR citizens. This is 2 of 3 blog posts based on our recent report “Business Formalization in the Lao PDR“.
Growing Small and Medium Sized Firms (SME)
The private sector in the Lao PDR is highly fragmented. Official figures for registered enterprises show that small enterprises (1-19 employees) comprise about 99% of all enterprises in the Lao PDR. The country has only about 1,100 medium- sized enterprises (20-99 employees) and 200 large enterprises (100 or more employees). While firms with fewer than 20 employees comprise a large share of total enterprises in many developing countries, the numbers for the Lao PDR are at the higher end of the spectrum.
Encouragingly, the share of registered small enterprises owned by women has been rising in recent years, from 44% in 2009 to 55% in 2012.
Not only are most registered firms in the Lao PDR small, they tend to stay small. Based on enterprise surveys conducted by GIZ in 2011 and 2013, only 6% of the small enterprises surveyed in 2011 had grown into medium-sized or large enterprises by 2013. Similarly, only 2% of the medium-sized enterprises surveyed in 2011 had grown into large enterprises by 2013, with 46% actually shrinking to small enterprises over the same period.
These statistics highlight a key challenge for PSD in the Lao PDR – small firms have difficulty growing into larger firms and achieving the scale necessary to improve their productivity and access to international markets.
The Problems with Informality
Given the limited available research on the informal sector in the Lao PDR, it is difficult to estimate its share of the total private sector. Anecdotal evidence suggests, however, that informal businesses play large roles in many sectors of the economy, including manufacturing, construction, trade, and services. Many registered firms complain about the competition they face from informal enterprises. The World Bank’s Enterprise Surveys for the Lao PDR in 2012 found that 77% of firms face competition from informal firms, while 27% of firms cited the “practices of competitors in the informal sector” as their single biggest obstacle, making it the most commonly cited top constraint.
In addition to creating an uneven playing field, high rates of informality undermine the government’s fiscal policy by narrowing the tax base to concentrate revenue collection on a smaller number of tax-compliant firms, which strengthens the incentive to operate informally.
Informality presents a number of disadvantages for the unregistered businesses themselves. Most significantly, their access to finance is constrained by their inability to obtain a bank loan, forcing them to seek capital from alternative sources such as informal money lenders (often at very high interest rates) and family members. Constrained by a lack of capital, many informal businesses are unable to invest in new systems, equipment, and technologies, or to achieve the scale necessary to become internationally competitive.
In addition, informal firms have greater difficulty accessing global supply chains, contracting with customers and suppliers overseas, and engaging in joint ventures with foreign businesses. Closer to home, they have added difficulties accessing business support services and development programs.
Why Stay Informal?
While a firm may choose to stay informal for a wide variety of reasons, a key driver is the benefit of staying “under the radar” of government officials, particularly with respect to business registration, regulatory compliance, and taxation. By avoiding the substantial time and monetary costs of complying with these requirements, informal firms enjoy a competitive advantage over registered firms in their industry. This competitive advantage is a key dynamic of the private sector in the Lao PDR.
High rates of informality in the Lao PDR suggest that many firms perceive that the benefits of registration (including improved access to finance and global supply chains) are outweighed by the costs of registration and compliance with regulations and taxation.