Back in the 80s, in his book The Other Path, Peruvian economist HernandoDe Soto promulgated the idea that what System D/the informal sector needs is for governments to trim the bureaucracy and make it easy to start businesses. If that happened, de Soto opined, businesses would naturally come in from the cold.
But, as this case study of Rwanda from East African Business Week shows, in the real world, things seldom work the way de Soto thought they would. In Rwanda, it only takes 6 hours to register a business--and the process is free if you do it online. Yet these 'free market' reforms have had no impact. The size of the country's informal sector has not declined. It still makes up 90 percent of the nation's economic activity.
To make formalization even more easy, Rwanda has just approved a new plan that allows businesses with a turnover of less than $20,000 to pay $200 or less in taxes. That's an income tax rate of just 1 percent. Even so, the Commissioner General of the Rwanda Revenue Authority, Ben Kagarama, admits that the new rules "might not necessarily kill the culture of tax evasion" and that he doesn't expect most businesses to sign up.
So what gives?
As the article notes, informal merchants are routinely harassed, brutalized, and arrested by the authorities. In other words, their sole experience of government power is repressive and corrupt. Indeed some people argue that many governments in the developing world are little more than officially licensed thuggish protection rackets.
In countries like Rwanda, System D is the most productive sector of the economy. Politicians need to take concrete steps to build partnerships with informal markets and System D merchant associations. That's how government becomes a legitimate player in the business sphere--by working with System D rather than trying to force businesses to conform to some abstract rules of formality. When System D businesspeople--who are the backbone of the economy--see the government provide concrete benefits to their markets, that's when they will get involved in a positive way in social and political change.