Nigeria’s shadow economy supports millions of people, but it also takes a toll on national revenue. By formalising this sector, the country can pave the way for better public services, a fairer tax system, and more inclusive economic growth, writes Chigozie Chukwu.

The existence of an extensive shadow economy in Nigeria reflects both a symptom and a cause of deep structural inefficiencies within the country’s economic system. While it serves as crucial support for millions who are excluded from the formal economy, its persistence creates major obstacles to national development.

If Nigeria formalised even a small segment of the informal sector, it would provide the country with a valuable fiscal opportunity. By bringing more informal businesses into the tax net, Nigeria can significantly boost its public revenue, paving the way for increased investment in essential areas like education, infrastructure, and healthcare, ultimately breaking the cycle of poverty and underdevelopment.

The shadow economy represents a significant part of the economy of Nigeria. It encompasses all the economic activities that occur outside the official regulatory framework. This includes a wide range of businesses, from street vendors to small, unregistered companies that manage to sidestep taxation and regulatory supervision.

Several factors contribute to the persistent growth of the shadow economy in Nigeria. The country’s high unemployment rate, hovering around 33 per cent, significantly affects people’s chances of finding stable employment in the formal sector. With job opportunities so scarce, many Nigerians are forced to seek work in the informal sector, where positions, though often unstable and unregulated, are more readily available.

The lack of regulatory enforcement plays a crucial role; without proper oversight, informal businesses can operate without accountability. This issue is further exacerbated by widespread corruption within bureaucratic institutions, where unethical practices frequently hinder fair competition, making it both difficult and discouraging for companies to register legally.

Finally, limited access to financial services continues to perpetuate the growth of the shadow economy. A large portion of Nigeria’s population remains unbanked, which limits their ability to secure loans, insurance, or other financial products that could help them transition into the formal sector.

Many micro-entrepreneurs find themselves relying on informal loans or conducting all their transactions in cash, which only deepens their economic marginalisation. This gap in access to financial services creates a significant barrier to formalisation, as small businesses often lack the resources needed to meet formal requirements.

Nigeria’s shadow economy significantly affects the country’s formal economic growth and long-term sustainability. A major consequence is the substantial loss of tax revenues for the government, which could be used to finance public services, the development of infrastructure and social programs.

The ongoing issue of economic transformation perpetuates a system whereby workers are frequently denied essential legal protection. This leads to a cycle of economic insecurity and deepens social inequalities. These obstacles make it tough for individuals to improve their socio-economic status and stifles overall economic growth by creating an environment where innovation struggles to thrive and productivity suffers.

To tackle these challenges, strategically incorporating the shadow economy into the formal sector could pave the way for a more equitable, fair, and resilient economic landscape in Nigeria, ultimately benefiting the broader population. The shadow economy in Nigeria is like a double-edged sword. It provides quick fixes for many people, but at the same time, it stunts formal economic growth. The consequence is significant, leading to stunted development and reduced competitiveness.

This creates a paradox whereby informal businesses proliferate, yet their presence weakens the economy’s overall potential. Without proper regulations and oversight, these operations can thrive, but they fail to contribute adequately to tax revenues, which are essential for funding public services and infrastructure. As a result, vital sectors like education and healthcare suffer from underfunding, which keeps poverty cycles going and hinders the development of human capital, an essential element for economic growth.

The prevalence of the shadow economy impedes Nigeria’s ability to compete, both at home and abroad. Businesses that operate outside the formal system often circumvent regulations that protect consumers and fair competition, leading to price distortions and eroding consumers’ trust.

As a result, it becomes challenging to attract local and foreign investments that are crucial to galvanising the economy and creating jobs. Investors typically look for stable and transparent environments, but the widespread informal practices create a sense of uncertainty that can scare off potential economic partners.

Solutions

To mitigate the adverse effects of the shadow economy and encourage its transition towards a more formal structure, Nigeria needs to prioritise several strategic approaches. First, strengthening regulatory frameworks is essential. By simplifying the legal registration process and compliance for companies, the government can relieve bureaucratic burdens that businesses and entrepreneurs view as barriers.

Nigeria’s shadow economy is estimated to account for over 60 per cent of GDP, yet it barely makes a dent in tax revenues. Recent figures show that Nigeria’s tax-to-GDP ratio is only around seven per cent, which is among the lowest in the world. Imagine if we could formalise just 20 per cent of that shadow economy and tax it at a conservative average rate of 10 per cent, this could bring in an extra £1.6 billion annually.

For context, Nigeria’s education budget for 2023 was just under £1 billion, with a reported underfunding gap of over £267 million for primary and secondary education. Redirecting a fraction of new revenues towards education could widen access, enhance teachers’ training, and fix up crumbling infrastructure.

Increasing access to finance and education also represents a critical pillar in the integration of the shadow economy. Financial institutions need to broaden their scope to include microloans and tailored credit options for informal businesses. This access can be fundamental to facilitate the transition to formalisation, allowing informal operators to grow their ventures responsibly.

Partnerships between the government and the private sector can lead to innovative solutions that improve formal economic structures and the productivity of informal businesses. For example, jointly designed programs that encourage formal registration can produce substantial benefits, filling the gap between the two sectors and minimising economic disparities.

Summarily, introducing tax incentives for formalisation could be a game changer. By offering temporary tax breaks or streamlining tax processes for newly established businesses, the government can ease the financial burden that often keeps entrepreneurs from operating legally. These incentives would not just boost the number of actors in the formal economy; they would also strengthen the tax base, paving the way for reinvestment in vital public services and infrastructure.

Transitioning to a formal economy is not just an economic necessity for Nigeria; it is crucial for sustainable growth and development. Successfully integrating the informal economy will create benefits that resonate throughout society, enhancing the overall economic landscape and ultimately securing a brighter future for generations to come.

Photo credit: zouzouwizman used with permission CC BY 2.0