Incentivizing Gray Market Entrepreneurs in Emerging Markets

Juana Paola Bustamante I. & Kevin J. Fandl | January 1, 2017

Abstract: Economic growth and development depends to a large extent on a fair marketplace, whereby all firms play by the same rules. Effective rule of law and strong regulatory enforcement regimes make this possible in most developed countries. Emerging markets are much less successful in regulating firms, leading to extensive informal economies replete with unregulated firms. These unregulated firms undercut the market by evading the costs associated with legitimate firm operations, skirting taxation and discouraging investment in the formal marketplace. Many emerging market governments have responded to this problem with formalization programs aimed at incentivizing the movement of informal firms into the formal economy. In this paper, we assess a recent and comprehensive formalization program to evaluate its strategy and success. We conclude that an incentivization program like this one, aimed at reducing the costs of doing business, misses the underlying structural deficiencies that lead to high levels of informality. We recommend a more nuanced approach that addresses productivity before attempting to formalize micro-enterprises.