We must deter, but not without trust: a case of formalising informal micro-entrepreneurs in Pakistan

Abstract

PurposeThe policy approach in Pakistan with regard to combating the informal economy has remained quite myopic and skewed in its reliance on measures informed by the rational economic-actor theory as opposed to the social-actor approach. Thus, this study attempts to evaluate and synthesise the two alternative policy approaches and formulate a more theoretically integrative understanding of the subject.Design/methodology/approachThe authors gather data from 600 micro-entrepreneurs operating in the retail and wholesale sector of Lahore, Pakistan, which is then analysed using an ordered logit regression technique.FindingsIn contrast to more developed countries, the finding here is that higher perceived penalties have a highly significant and positive impact on the level of formality of Pakistani micro-entrepreneurs. The perceived risk of detection, meanwhile, has only a moderately significant impact on the micro-entrepreneurs level of formality. Likewise, the level of vertical and horizontal trust has a positive but moderately significant impact on the level of formality. Nonetheless, both the vertical and horizontal trust exhibit a very significant moderating effect on the relationship between the use of penalties and the level of formality, that is, the higher the level of trust that the micro-entrepreneurs have in the state and other businesses, the lower is the effectiveness of punitive measures.Practical implicationsDeterrence is an effective way to enhance the level of formality in the case of the Pakistani context. Nonetheless, the authors imply that without building trust, this overreliance on punitive and detective measures can actually be counter-productive. A combined and congruent (not sequential) use of voluntary compliance measures is thus warranted.Originality/valueIt is a unique attempt to evaluate and synthesise the global policy theorisations in a non-mainstream and antagonistic climate, such as Pakistan.