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The McKinsey Global Institute (MGI) recently released research on the negative effects of the “informal” economy. Informal companies engage in legitimate business activities but don't fully comply with tax and regulatory obligations, which in turn dampens productivity and economic growth.
In recent months, Heinz-Peter Elstrodt, leader of McKinsey's Mercosur office complex (Brazil, Argentina, Chile), has been promoting a report based on MGI's work that pinpoints the detrimental effects of informality on business in Brazil. He spoke recently about what can be done to help fight unfair competition to improve the business climate for all players and spark growth.
 | | What can actually be done to confront the spread of informal business practices in Brazil ? Answer |
| | | | What do you see as the number 1 priority in addressing informality? Answer |
| | | | How receptive are executives to confronting informality in their region? Answer |
| | | | Have you seen any progress in Brazil? Answer |
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| | | What can actually be done to confront the spread of informal business practices in Brazil ? | | There are two approaches to addressing this issue, one short-term and one medium-term. In the short term, Brazil needs to take specific steps at the sector and functional level. Few have studied the informal economy but, when you do, you find that it takes very different forms in different sectors. Once you are at this level, you can look at the value chain and take quick actions that will mitigate problems. In the Brazilian soft drinks and beer industry, for example, volume meters are being installed in all bottling lines. Tax authorities will read these meters online, drastically reducing tax evasion in this industry practically overnight.
On the functional level, reforms such as making it much easier to open a business or to get a title on a piece of property go a long way.
The second, more medium-term approach is for the government to push through comprehensive reforms covering taxes and the legal system to name a few. But getting these reforms passed could be very difficult because, as with any political system, there are a lot of competing interests.
| | | | | | What do you see as the number 1 priority in addressing informality? | | | The first priority is to build awareness about why fighting informality is important. The prevailing popular opinion today, unfortunately, is that fighting informality just means that big companies beat up on their smaller competitors. In addition, consumers tend to think that if a retail store evades high sales taxes, for example, the savings are passed on to them. However, few people understand that informality really acts as a major brake on productivity growth, the major driver of GDP and job growth. In Brazil, we are just starting to see the political leadership get engaged.
| | | | | | How receptive are executives to confronting informality in their region? | | In most of the sectors of the Brazilian economy, business leaders will say that informality is their number 1 or number 2 issue. The formal sector is losing market share and seeing margins drop. In many segments of the consumer goods industry, formal companies are withdrawing from the market while others are not investing. This situation has gotten worse in the past few years, so it is easy to direct attention to this issue.
Where it gets more difficult is in getting leading companies to join together and undertake major initiatives to combat informality. Naturally, these companies see each other primarily as competitors. What we say is, if you really think about it, you need to work together with your competitors. The informal sector is a bigger threat to you than you are to each other. In addition, if you can work together and show leadership you can come up with practical suggestions, you could start a real movement.
Then comes the next hurdle: do companies believe that the government will actually implement sensible policies? This is a chicken and egg problem – the government complains that the proposals coming from the private sector are often not founded on sound microeconomics and don’t take into account the public good, while the private sector complains that government doesn’t implement any of their suggestions. Combating informality is in the interest of both the country and the large, formal companies. Any proposal has to take into account these dual interests, which is a very high standard to attain. | | | | | | Have you seen any progress in Brazil? | | After we finished the study of informality and its impact on the Brazilian economy, we co-led a big event to promote the findings together with ETCO (the Brazilian Institute for Ethical Competition), a not-for-profit group that fights unfair competition. We presented our point of view and our fact base on informality. Then panels of government officials and CEOs debated and responded to our presentation – and mostly agreed with us, I’m happy to say. The event was broadcast on television on a number of shows, including a program called Journal Nationale that is watched by the vast majority of Brazilians.
The report was released 2 months ago. Awareness of the issue is definitely higher and the government is becoming more receptive. Part of the problem is that the government itself is so complex and disjointed. To combat informality effectively, several different ministries have to be coordinated, including justice, finance, and trade. But the government is in the process of taking a first step to mitigate that problem by creating a cross-ministry agency to help with coordination. | | | | |
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| | | | McKinsey Global Institute: The Informal Economy | |
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