World Bank
From the SelectedWorks of Mohammad Amin
October, 2009
How different are service and manufacturing firms
in the informal sector? (Short Note)
Mohammad Amin
Available at: http://works.bepress.com/mohammad_amin/14/
How different are service and manufacturing firms in the informal sector?
A comparison of service and manufacturing firms in the informal sector shows that service firms are
larger in terms of total sales and also generate more output per worker. They rely less on physical
infrastructure and machines but more on human capital. Service firms also appear to be better integrated
with the financial system with access to finance being less of an obstacle to their business. Some of the
commonly held reasons for not registering such as taxes that registered businesses have to pay and
benefits from registering such as better access to government programs appear to be less important to
service than manufacturing firms. Last, there are important country specific differences between service
and manufacturing businesses in, for example, female ownership and the motivation for starting the
business.
There is a growing body of work that suggests that services and manufacturing firms differ fundamentally
in the overall structure and growth dynamics. However, this literature is almost entirely based on service
and manufacturing firms operating in the formal or registered sector. Anecdotal evidence suggests that in
many developing countries, a large proportion of the population works in the informal or the unregistered
sector. What are the differences between service and manufacturing firms in the informal sector? This
note attempts to shed light on this question using data on informal firms in Ivory Coast, Madagascar and
Mauritius (Enterprise Surveys). The exercise is important for a variety of reasons. First, it is not obvious
whether the findings for the formal sector can be extended to the informal sector. For example, most
informal firms operate on a small scale so that size related differences between manufacturing and service
firms in the informal sector may not be as relevant as in the formal sector. Second, informal sector is
often criticized for being inefficient and hence a drain on scarce resources. If more efficient utilization of
resources is indeed a policy objective for bringing the informal sector into the fold of the formal sector, it
would help to know exactly which informal firms (manufacturing vs. services) are more intensive users of
resources most scarce in a particular country. Third, effective policy measures aimed at getting the
informal firms to register require understanding the reasons why firms choose to go informal and remain
informal. These reasons could vary across service and manufacturing firms for a variety of reasons. For
example, relative to service firms, manufacturing firms are typically larger and so prime targets for
inspections by government officials. This could be an important motivation for manufacturing firms to go
informal. Similarly, proposed benefits from registering such as access to finance and electricity may be
more important to manufacturing firms than service firms since the former require larger investments in
machinery and equipment and are also more intensive users of electricity. Fourth, service and
manufacturing activities are easily identifiable so that if we do find differences between these two sectors
then policy measures can be tailor made to their respective needs. Fifth, lower entry costs for service
firms may be particularly attractive to females who often face difficulty in accessing credit. Also, service
firms can be more easily run from within household premises than manufacturing firms which is also
attractive for female workers. Issues related to gender parity warrant a closer look at service vs.
manufacturing informal firms.
1. Service firms are larger and generate more sales per workers
Total sales in a regular month for a service firm equal USD 300 compared with USD 218 for a typical
manufacturing firm. That is, the former is about 138 percent of the latter in the full sample. The
corresponding figure equals 113 percent for Ivory Coast, 140 (Madagascar) and 150 (Mauritius). In
contrast, total employment does not show any systematic difference between a typical service and
manufacturing firm. Relative to a manufacturing firm, employment in a service firm is higher by 3.3
percent in the full sample (1.48 vs. 1.57), 22 percent in Ivory Coast and 6 percent in Mauritius. However,
it is lower by 20 percent in Madagascar. For sales per workers, a measure of firm efficiency, service firms
outperform manufacturing firms except in Ivory Coast (figure 1). The difference is particularly sharp for
1 firms where the main decision maker has less than secondary level education (primary or no education)
and for firms that were started because the largest owner could not find a satisfactory job (unwilling
entrepreneur) rather than to take advantage of a business opportunity.i
Figure 1: Service firms generate more sales per workers
Total sales per employee (USD, normal month)
Output per worker: service vs. manufacturing 400
350
300
250
200
150
100
50
0
All firms
Ivory Coast Madagascar
Mauritius
Manufacturing
Less than Unwilling secondary entrepreneur
education
Services
Source: Enterprise Surveys
Less than secondary education implies that the main decision maker is has either primary education or no education.
Unwilling entrepreneur refers to firms that were started because the largest owner could not find a satisfactory job rather than to
take advantage of a business opportunity. Values of output per worker shown are their median values.
2. Service firms rely less on electricity and machines but more on human capital
Service firms score over manufacturing firms in terms of the education level of the main decision maker
and this holds across all three countries (figure 2). The difference is particularly sharp in the relatively
smaller cities and for firms that have all male owners. Education level is also much higher in service
relative to manufacturing firms that have unwilling entrepreneurs. A plausible interpretation of this
finding is that due to lower entry costs, service sector is more attractive to those unwilling entrepreneurs
who are educated and hence expect to find a wage earning job in the near future.ii
2 Figure 2: Main decision maker in service firms is more likely to be educated than in manufacturing
firms
Percentage of firms
Percentage of firms with main decision maker having secondary or higher education
90
80
70
60
50
40
30
20
10
0
Full sample
Ivory Coast
Madagascar
Mauritius
Manufacturing
All male owners
Small city Unwilling (Population entrepreneur
less than 250,000)
Services
Source: Enterprise Surveys
Unwilling entrepreneur refers to firms that were started because the largest owner could not find a satisfactory job rather than to
take advantage of a business opportunity. Values of output per worker shown are their median values.
As expected, relative to manufacturing, service firms are less likely to use electricity (53 vs. 69 percent)
and machinery (26 vs. 62 percent). They are also less likely to operate outside the household premises (24
vs. 41 percent). However, use of vehicles or other means of transport is roughly same in the two sectors
(14 vs. 12 percent) and the same holds for cell phones (76 vs. 79 percent) and Email to communicate with
clients and suppliers (92 vs. 96 percent).
3. Service firms are better integrated into the financial system
Over 46 percent of the service firms have a bank account to run the business and 30 percent have a
business account that is separate from the household account. Corresponding figures for manufacturing
firms are much lower at 33 and 20 percent, respectively. Similarly, financial accounts of the business are
run separately from the accounts of the household for over 50 percent of the service firms but only 34
percent of the manufacturing firms. These findings suggest better banking habits among service firms.
Service firms also score over manufacturing firms in the percentage of firms that use bank finance for
their day to day operation (6 vs. 2 percent) and the same holds for microfinance (5 vs. 1 percent). Note
that the percentage of firms using bank finance or microfinance in both the sectors is low so that it is
difficult to make any definitive conclusions from the reported differences. At best these findings are
indicative of better access to external financial institutions for service relative to manufacturing firms.
This is further corroborated by the fact that fewer service relative to manufacturing firms report access to
finance as major or very severe obstacle for running their business (44 vs. 53 percent).
3 Consistent with the findings reported above, less than 10 percent of all firms applied for a loan during the
year prior to the survey. The percentage is lower among manufacturing compared with service firms (8
vs. 12 percent). Lack of collateral as the main reason for not applying for a loan is significantly more
common among manufacturing relative to service firms (figure 3), a somewhat surprising result since
machines and equipments used by manufacturing firms could be expected to useful collaterals.
Figure 3: Lack of collateral required for a loan is a more common problem among
manufacturing than service firms
Main reason for not applying for a loan (% of firms)
No need for a loan
Application procedures are complex
Did not have required guarantee
Did not think it would be approved because the firm is unregistered
Interest rates are too high
Other 0
5
10
15
20
25
30
35
40
45
Percentage of firms that did not apply for a loan
Manufacturing
Source: Enterprise Surveys
Services
All figures are expressed as percentage of firms that did not apply for a loan during the year prior to the survey.
4. Production structure and basic firm characteristics are similar between service and
manufacturing firms
With a few exceptions, service and manufacturing firms show very little difference in the production
structure or firm characteristics such as age, probability of having one or more female owner, total
number of owners, hours of operation in a typical week, proportion of output that the main
product/service represents, ratio of paid to unpaid workers and the level of seasonality measured by the
ratio of sales in the busiest to the slowest month. Also, we find virtually no difference in the gender
composition of the workforce between services and manufacturing firms, a finding that is sharply
different from existing studies on the formal economy that suggest greater concentration of women in
services vs. manufacturing sectors. Differences that do exist in some of firm characteristics discussed
above are largely confined to a single country (discussed below). Three exceptions are that relative to
service firms, manufacturing firms are much more likely to produce under contract for another business or
person than service firms (14.2 vs. 4.5 percent), more likely to operate outside than within household
premises (41 vs. 24 percent) and have managers with more experience working in the industry (12.7 vs.
9.4 years).
4 5. Benefits/costs of registering
The survey reports on the severity of various obstacles to registering as experienced by the firms. These
obstacles include getting information on registration procedures, time to complete registration and the
required fees, taxes on registered businesses, inspection and meetings with government officials that
registered business must have and bribes that registered businesses need to pay. On average, service firms
report the severity of these obstacles at par with the manufacturing firms and in some cases, lower.
Obstacles less severe for service firms include getting information on how to register, registration fees
and bribes that registered businesses pay.iii
Looking at which of the above obstacles is most important to service vs. manufacturing firms, there are
important differences at the country level (figure 4). For example, in Madagascar, taxes on registered
businesses are the important obstacle for 51 percent of service firms compared with 42 percent of
manufacturing firms. Corresponding figures for registration fees are 23 and 32 percent, respectively.
Figure 4: Most important reason for not registering in services vs. manufacturing varies by country
Most important reason for not registering (% of firms) Percentage of firms
70
60
___Ivory Coast___
____Madagascar___
_______ Mauritius____________
50
40
30
20
10
0
Getting Fees for information registering
for registering
Fees for registering
Taxes on Getting Time to registered information complete businesses
for registration
registering
Manufacturing
Taxes on registered businesses
Services
Source: Enterprise Surveys
For the perceived benefits from registering, firms were asked about better access to finance, raw
materials, markets, services, workers, government programs, less bribes to pay, better legal foundation on
property rights and better opportunities of negotiation with formal firms. Much like the obstacles
discussed above, percentage of firms reporting the benefits as important was lower for services firms in
some cases and roughly same as the manufacturing firms in the remaining cases. The former cases
include access to government programs (57 vs. 67 percent) and access to workers (39 vs. 50 percent).
5 Better access to markets and better access was also more common for manufacturing relative to service
firms in Madagascar, and to some extent, Ivory Coast.
How do service vs. manufacturing firms rank the benefits listed above? The answer to the question varies
by country (figure 5). For example, in Ivory Coast, better access to markets is the most important benefit
for 15 percent of manufacturing firms but only 3 percent of service firms. Corresponding figures for
better access to finance are 69 and 78 percent, respectively.
Figure 5: Most important benefit from registering in services vs. manufacturing varies by country
Most important benefit from registering (% of firms) 90
Percentage of firms
80
Ivory Coast__ __________Madagascar___________
___ Mauritius____
70
60
50
40
30
20
10
0
Better access Better access Better access More access to Better access More access to Better access to financing
to markets
to financing government to markets
government to markets
programs or programs or services
services
Source: Enterprise Surveys
Manufacturing
Services
6. There are important country specific differences across sectors
Female ownership in Ivory Coast: Ivory Coast stands out from the other countries in the percentage of
service vs. manufacturing firms with one or more female owners. About 48 percent of service firms but
only 25 percent of manufacturing firms in Ivory Coast have a female owner. There is virtually no
difference in female ownership of service vs. manufacturing firms in Mauritius (31 vs. 30 percent) and
Madagascar (50 percent each).
Unwilling entrepreneurs in Madagascar: Many informal businesses are started because the owner(s)
cannot find a satisfactory job (henceforth, unwilling entrepreneurs) rather than to take advantage of
business opportunities. The distinction between these two motivations for starting a business is important,
both for policy measures and understanding how informal businesses function. For example, an unwilling
6 entrepreneur may not have the skills or the inclination to run a business implying a distortion in the
economy. Bringing the informal firms into the fold of the formal sector does not necessarily eliminate this
distortion. Hence what may be needed are more wage jobs and not just getting informal firms to register.
How do service and manufacturing sectors compare in the proportion of firms established because the
largest owner could not find a satisfactory job? Madagascar stands out for the high proportion of such
firms in the manufacturing relative to service sector (48 vs. 29 percent). The corresponding figures equal
42 vs. 48 percent in Ivory Coast and 35 vs. 27 percent in Mauritius, respectively.
Selling goods and services on credit in Mauritius: Service and manufacturing firms in Mauritius show
a number of differences that are unique to the country. For example, less than 14 percent of the service
firms but over 38 percent of manufacturing firms in Mauritius report selling their goods/services on
credit. Corresponding figures for Ivory Coast are 63 and 58 percent and 38 and 45 percent for
Madagascar, respectively.
The effectiveness of policy measures aimed at improving the functioning of firms in the informal sector
and the proposed benefits from such policy measures depend crucially on the sorts of firms that operate in
the sector, how they do business and the main obstacles they face in doing so. That these dimensions may
vary across service and manufacturing informal firms is neither obvious nor implausible. It is an empirical
question that this note attempts to explore. In addition to size, output per worker, infrastructure usage,
human capital and benefits/costs of registering related differences, there are important country specific
features that distinguish service from manufacturing firms. Depending on the objective, policies towards
the informal sector may need to be tailored to the country in question.
i
Values of total sales and output per workers are the median values for the various samples discussed. The qualitative analysis does not change much if arithmetic means are used instead although in some of the cases these are unduly affected by extreme values. ii
Note that the education level refers to the main decision maker while the motivation for starting the business refers to the largest owner. However, for on overwhelming percentage of firms (over 95 percent), the main decision maker is also the largest owner. iii
One exception is Ivory Coast where service firms report bribes that registered business must pay to be a bigger obstacle for registering than manufacturing firms. 7