Informality and Inclusive Growth: What Lessons in the Literature from the African Experience?

The informal sector and inclusive growth have a very close relationship that fuels an extremely fertile literature. The objective of this paper is to determine the effects of the size of the informal sector on inclusive growth in Africa using data for 43 countries from Medina and Schneider (International Monetary Fund, 2018) and the World Bank (World Development Index, 2021). After constructing the inclusive growth index based on an appropriate methodology, we specified and estimated respectively a panel data, fixed effects Driscoll and Kraay model with robustness via Lewbel 2SLS and system generalized method of moments (S-GMM) over the period 1995-2019. Our results show that the informal sector significantly and statistically reduces inclusive growth in Africa. Furthermore, our results show the existence of a U-shaped relationship between the size of the informal sector and the level of growth inclusiveness. These results are robust to alternative specifications. We suggest that governments introduce less stringent forms of regulation to encourage firms operating on the edge of legality to evade taxes to better regulate themselves and thereby contribute to growth, poverty reduction and environmental sustainability, rather than encouraging (or discouraging) the informal sector per se.