in some developing countries, quite large enterprises with several hundred employees. Some firms may be registered with one set of authorities but not another, for instance, or be registered but under-declare sales or workers for tax purposes.

‘Formalization’ refers to the process whereby previously non-compliant enterprises become integrated into these formal or state-sanctioned institutions, such as property registries and tax-rolls. We know relatively little about how this occurs in practice. Public policy may have a role to play, but the process need not necessarily take place under state sponsorship. The experience of some developed countries, Italy in particular, suggests that inducing regulatory compliance requires a combination of self-interest on the part of entrepreneurs, government intervention and ongoing self-monitoring (Locke and Criscuolo, 2006). The particular mix of public intervention and private initiative is also likely to vary from country to country and by type of enterprise. Since our concern is to encourage the growth of markets for products, finance and skills, most of the examples in this paper are drawn from cases of tax and product market formalization. But the mechanisms that promote compliance in these areas are similar to those for other forms of upgrading.

In thinking about formalization, we should acknowledge that formal or state-sanctioned institutions are more likely to succeed when they build on existing informal arrangements. The term ‘accommodation’ implies compromise on both sides. There must a commitment to compliance on the part of entrepreneurs. But ‘bureaucratic institutions [also] need to be more flexible in their treatment of informal practices, so that more people can take shelter under the rule of law’ (Hart, 2006, 13). This can involve adapting orthodox institutions for unorthodox ends – as in Ghana, where the road transport workers’ union (GPRTU) has collected taxes on behalf of the state since the late 1980s and has the authority to enforce safety standards among its members (Joshi and Ayee, 2002); or Kenya and Tanzania where commodity marketing boards have performed a similar revenue-raising function.<sup>1</sup>

# _When is formalization appropriate?_

We begin from the assumption that in so far as there is scope for a voluntary accommodation between informal enterprises and the state in developing countries, it should be encouraged. How large is the potential for such a bargain? The short answer is that we have no comprehensive data. But an IFC survey of Sierra Leone, for example, found that 80 percent of informal entrepreneurs would consider formalizing over the coming year. Another study of informal firms in South Africa found that only 24 percent thought their ‘present level of compliance was sufficient, or saw no disadvantage in informal status’ (SBP, 2005, 14). No doubt some informal enterprises would disappear if forced to comply with government regulation and it may well be that from some points of view integration into state-sponsored institutions does not make sense. But the potential for voluntary formalization would also appear to be large.

> 1 Interview with Vandana Chandra, Senior Economist, Economic Policy and Debt Unit, Poverty Reduction Economic Management Network, World Bank.

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