ANALYSIS: How Nigeria, South Africa should approach their informal sectors

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Nigeria and South Africa are Africa’s largest economies, and their development significantly impacts their regions and the continent as a whole. Updated forecasts by the African Futures and Innovation (AFI) team at the Institute for Security Studies (ISS) reveal the varying impact of the informal sector on both economies and their regions.

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South Africa’s informal sector accounts for 17 per cent of its labour force, significantly lower than Nigeria at 68 per cent and Africa’s average of 58 per cent. Our analysis shows how context-specific approaches to informality could contribute to inclusive economic growth and reduce unemployment.

Compared to West Africa, Southern Africa’s development has been lacklustre when unemployment is used as a yardstick. According to International Labour Organisation (ILO) data, Southern Africa had the highest unemployment rate globally at 33.2 per cent in 2024.

Eswatini, South Africa and Botswana rank first, second and fifth in the world regarding unemployment rates. With its poor-quality education and limited entrepreneurship, South Africa’s employment is particularly low, and inequality is exceptionally high. The Southern African region fares the worst globally on both unemployment and inequality.

West Africa does better than other African regions in terms of employment, mainly because the ILO’s employment definition includes people active in the informal sector, where livelihoods are fragile and uncertain. The ILO estimates unemployment in West Africa at just 2.9 per cent, whereas Central, East and North Africa have rates that are more than three times higher.

The reason for West Africa’s low unemployment figures is that the region has one of the largest informal sectors in Africa. Southern Africa, by comparison, has a relatively smaller informal sector, which provides less of a cushion against unemployment than in other parts of the continent. The region’s low employment levels are also linked to generally high levels of inequality.

Southern Africa’s smaller informal sector is rooted in its historically extractive policies based on minerals and cheap labour. Also, countries in the region only recently transitioned to majority rule (South Africa was the latest, in 1994).

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With ruling parties heavily infused with socialist ideological models from several decades ago, governments offer little room for self-help and are often hostile to the private sector, most evident in Zimbabwe. As a result, economic emancipation has not yet taken place. Governments promise to provide for their citizens, but rarely do.

Economic ideology is compounded by the centralised, monopoly structure of the South African economy, in particular. Big farming, retail and manufacturing limit informal and small business opportunities. As a result, organisations as diverse as South Africa’s Competition Commission, the World Bank and the Organisation for Economic Co-operation and Development have called for unlocking the potential of small businesses and entrepreneurship.

AFI-ISS modelling shows that while development is generally associated with a gradual reduction in the informal sector – both as a share of gross domestic product and regarding labour force participation – South Africa is likely to experience an increase. This is primarily driven by the business-as-usual forecast of slow economic growth over the next decade, averaging 2.4 per cent.

At low levels of development, the informal sector is generally much less productive than the formal sector, but the gap typically reduces as countries move up the income ladder. At higher levels of development, a large informal sector often reflects a determined effort to avoid regulation compared with being survival-oriented in countries with low levels of development.

So, in some high-income countries, informal sector productivity could be similar to that in the formal sector. For example, in Russia, Italy, and Greece, where the illicit economy is large, informal sector productivity likely resembles that of the formal sector.

Irrespective of the level of development, a large informal sector is costly for society and constrains sustainable development. Informal sector workers do not pay personal or company tax, but still require infrastructure and government services. However, this drag is somewhat balanced by the informal sector’s absorption of people who would otherwise not earn any income.

The ILO data on unemployment in Africa is therefore quite misleading without appropriate context. That is revealed in Afrobarometer’s 2021-2022 survey across 39 countries, in which many more youth aged 18 to 35 said unemployment should be their government’s leading policy priority.

This presents a counterintuitive but important insight: while informality is typically associated with poor working conditions, South Africa and Nigeria face opposite challenges in this regard.

For South Africa, the formal sector is capital-intensive and not job-rich. It creates limited work opportunities, while the informal sector is too small to absorb the country’s large unemployed population. South Africa needs to allow an expansion of its informal sector as one of a host of measures to serve as a crucial safety net and offer some form of livelihood in the short term.

In Nigeria, the informal sector is extremely large, hiding widespread underemployment and low productivity. Its size results from a complex combination of economic, institutional and structural factors. Although unemployment rates appear low, most jobs are precarious and unregistered.

This weakens the state’s ability to collect taxes, regulate economic activity and provide quality services. The country has some of the lowest tax-to-GDP rates globally, with a large portion of its taxes not collected due to low government efficiency and corruption.

As a result, Nigeria needs a determined effort to move large portions of its informal sector into the formal sector. This gradual process – for example, through digital tax platforms and national ID systems – is not easy for any government, and is particularly challenging given low levels of trust in government in Nigeria.

Countries like Rwanda have pioneered digital business registration and simplified tax regimes to draw informal workers into the formal economy, possibly offering useful lessons.

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Should these divergent approaches, and other measures to enable rapid and inclusive growth, succeed, the South African economy could be 60 per cent larger in two decades, and that of Nigeria, 50 per cent larger. Realising this potential prosperity depends on context-specific, possibly uncomfortable approaches to human capital development, taxation and state-citizen trust.

The informal sector is no peripheral issue; it is central to questions of state capacity, inclusion and the future of work. How governments respond and whether they can harness informality as a bridge rather than a barrier is crucial to building economic resilience.

Jakkie Cilliers, Head, African Futures and Innovation, Institute for Security Studies (ISS) Pretoria

(This article was first published by ISS Today, a Premium Times syndication partner. We have their permission to republish).