Mr David Marston, former International Monetary Fund (IMF) employee and expert on global economics and risk management
At the PSOJ/JMMB annual economic forum held July 16, 2019, Mr David Marston, former International Monetary Fund (IMF) employee and expert on global economics and risk management, made a strong case for the local financial sector to be more inclusive of the creative sector. Marston noted that “financial inclusion should be approached not only from the point of view of provision of loans, but also leveraging neglected assets, such as music and culture”.
As an expert on risk, Mr Marston would be aware of the many arguments about why areas like music and culture have not been able to access the financial sector.
One important argument is the informal nature of many of the operators in the creative sector. The heavily regulated financial sector is required to operate within very formal structures. This means that borrowers are expected to meet some minimum operating criteria to satisfy regulators. Financial institutions must know their customers and ensure that they are not banking individuals and businesses who are breaking a myriad of laws and regulations, including international agreements. These laws and regulations cover, inter alia, terrorism financing, money laundering, and tax evasion.
Even while meeting these stringent conditions, financial institutions should, however, seek to take on board the constructive points made by Mr Marston, given the need to diversify portfolio away from the status quo of “government assets and a few corporates”. The main challenge remains how to get more of the creative sector into the formal economy. Given the reality of the Jamaican financial industry, with growing liquidity for lending and investing, to support small and medium-sized entities, much more needs to be done to reduce informality in the Jamaican economy.
THE INFORMAL SECTOR SIZE
During the 2000s, the Jamaican informal sector was estimated at about 40 per cent of the total economy. This includes pure tax evasion by properly registered businesses that fail to report earnings from legal activities; irregular economy, which represented the output from unregistered small and medium businesses; and illegal activities, which are not measured.
There is little evidence that much has changed to reduce the incentive for informality over the last 20 years. Even with improvements in the Ease of Doing Business index, tax reform and other positive changes in the business environment, informality is still deeply embedded in the business culture. And the degree of informality is an index of underdevelopment.
In studies by the IMF in the 2000s, poor developing countries, like Jamaica, were found to have between 35 and 50 per cent of their gross domestic product (GDP) in the informal sector. For transition economies in Eastern Europe, it was found to be between 21 and 30 per cent, and up to 15 per cent for developed, Organization for Economic Cooperation and Development economies. Informality prevents businesses and individuals from accessing financing from the financial industry and thus hold back their growth and development. It robs government of legitimate revenue for development expenditure; it also feeds income inequality and weakens social capital. Low-income earners who pay taxes are at a disadvantage vis-à-vis those who evade taxes.
There is much that the Government can do to reduce informality. Simply offering loans to informal businesses to do better bookkeeping, and to train in better business practices will not be enough. Much of the informality we witness is caused by regulatory and tax distortions which can only be addressed by the Government.
The cost of becoming formal is currently too high relative to the benefits. The ineffectiveness of the tax authorities and the low level of prosecution for tax evasion reduce the urgency for greater formality. There is a great need for the Government and the financial industry to come up with solutions to get a much larger proportion of the informal sector to become formal. The design of an appropriate incentive structure to overcome the current regulatory and tax distortions is not beyond the national capacity.
The informal sector represents a diverse group of businesses and workers, ranging from peddlers, service providers, traders, to sophisticated entrepreneurs. They play an important role in employment creation, social welfare and stability. The sector cannot, therefore, be ignored or be driven out of existence. If ignored, it will continue to undermine the formal sector and those who operate legitimately.
As Mr Marston pointed out, Jamaica has got to get small and medium savers to borrow more. Faster GDP growth beyond the low 1 to 1.7 per cent annual rate is needed, but this cannot take place unless businesses expand. For this, they need to access credit more widely from the formal financial syetem. Reducing informality should become a major strategic objective of the Government to realise faster growth and reduced poverty.