to depend on the nature of relations between the state and informal private sector. Where firms are registered but not paying taxes, for instance, it may be appropriate to concentrate more on enforcement and information-sharing. Where enterprises are wholly outside the system, the inducements may need to be more positive, as we discuss in more detail below. First, though, why might such an arrangement be difficult to arrive at?

# _Informality as a strategic problem_

_Coordination:_ One reason is that, like many other social situations, the formalization decision is strategic – it depends on the decisions of others. It probably does not make sense for an entrepreneur to incur the costs of compliance with government regulation unless he or she can be sure that his or her competitors do the same. The underlying problem is a lack of coordination: Why pay taxes, register or comply with costly health and safety standards when nobody else does? Not only are you unlikely to receive any public services in return, you also place yourself at a severe competitive disadvantage. The result is that informal firms have little incentive to formalize and formal ones are deterred from investing and expanding – with potentially serious consequences for growth in output and productivity.

_Credibility:_ But there is another dimension to the problem. Not only does individual compliance depend on other entrepreneurs’ behavior; it also depends on the government upholding its side of the bargain. Once registered, it is harder for enterprises to evade predatory as well as legitimate interventions by the state. It is quite common for national governments to declare themselves in favor of ‘promoting the informal sector’ at the same time as municipal authorities harass informal entrepreneurs and destroy their equipment and premises. It is also common for officials to backtrack on a commitment – as in Morocco, where the local government in Marrakech first guaranteed street vendors a reduced tax rate if they registered their businesses and then once they had done so charged them four times the promised amount and required them to pay back taxes for the past five years (Citron, 2004, 110). Persuading informal enterprises to formalize requires governments to commit credibly against this sort of behavior.

_Information:_ Lastly, successful cooperation requires information about the benefits of participation. This may seem obvious but it is surprising how many government programs in developing countries fail to communicate with their intended beneficiaries. According to the IFC survey of informal firms in Sierra Leone, lack of information is the single most important deterrent to acquiring a business license – ahead of costs and inconvenience (FIAS, 2006, 40). A 2001 Tanzanian government tax simplification program failed because, crucially, the authorities did not inform entrepreneurs about the change (USAID, 2005, 31). And a study of the informal sector in Kenya concluded that ‘only a tiny fraction of the _jua kali_ [informal sector workers] know anything about the myriad schemes and projects designed to assist them’ (King, 1996, 191).

The relative prevalence of these obstacles to formalization is likely to vary according by economic environment and firm type, as the table below shows. Coordination is likely to be more of a problem when informal enterprises compete directly with formal ones or 6