Urbanization, the Informal Economy, and Microfinance

> Posted by Joshua Goldstein, Principal Director for Economic Citizenship & Disability Inclusion, CFI

It has always been my unexamined belief that as economies mature the so called “informal sector” will shrink and with it the microfinance market. Sometimes unexamined beliefs based on instinct or intuition turn out to be right when subject to a fact-rich inquiry. But not this time. Upon investigating I uncovered growth trends in the informal sector and in urbanization, suggesting a refocusing for microfinance.

The informal sector is growing everywhere in the world. This segment of the economy, though its definition varies, includes activities of the working poor that are unrecognized, unrecorded, unprotected, or unregulated by public authorities. In more developed countries, also considered part of the informal economy are employment positions that have tenuous connections between the worker and formal structures and few, if any, labor rights or benefits. Globally, estimates for the total informal economy vary between 50 and 60 percent of the world’s population. According to Gallup’s 2012 World Survey, only about 40 percent of adults around the world, across all countries and income groups, have a fixed income for over 30 hours per week.

In India, when looking at the non-agricultural sector, 71 percent of workers in rural areas and 67 percent of workers in urban areas are operating in the informal economy. Some poor countries have informal economies that include over 80 and even 90 percent of the population. Not surprisingly, self-employed women make up the majority of informal sector workers. Much of informal work is done from the home.

In wealthier nations where formal sector employment and its benefits have been more the rule than the exception, the environment is changing. In France, for example, 86 percent of new hires are temporary workers. In Japan, the percentage of temporary staff is about 38 percent, with more than half of the female working population holding such positions.

A backdrop to this growth is the rise of urbanization. The urban population in the developing world is expected to nearly double in size between 2000 and 2025, from almost 2 billion to more than 3.5 billion. It is projected to surpass the rural population by 2020. Conversely, the rural population in developing countries is projected to stop growing after 2020, at about 3.1 billion. About 90 percent of the world’s population growth out to 2025 is expected to come from urban areas in developing countries. Beyond these forecasts, the urban population and urbanization are expected to continue increasing.

The implications of urban informality for the microfinance industry are self-evident: the services microfinance offers will continue to be relevant and their market will grow.  MFI strategic plans should factor in an ever growing urban client base and the proportional shrinking of the rural one. If this happens, how might the industry landscape reshape? Investors in regulated institutions will surely be happy that densely populated cities mean lower operational costs and therefore higher margins than in rural areas. But if such dense client bases are available, perhaps this wealth could be leveraged to enable institutions to expand service for the harder to reach rural clients. Through the changes, it will remain essential that the industry strives to adequately serve both urban and rural client segments.

Image credit: uusc4all

Have you read?

Financial Inclusion by 2020? Five Global Trends that Will Shape the Answer

Microfinance for Housing in Africa’s Cities

Taxes – Necessary Evil or Blessing in Disguise?