Paraguay’s economy has grown above the Latin American average in the past fifteen years. However, this growth has been based on the accumulation of factors of production, and in the face of meager gains in productivity, the dynamism of the economy wanes.
As a result, Paraguay, like many countries in the region, has fallen into the trap of low productivity and high informality, which reflects multidimensional structural barriers to productive development.
Indeed, a recent study by the Islamic Development Bank, titled The Paraguayan Formalization Challenge: Reasons, Motivations, and Policy Proposals, found that there are many factors that influence the decisions of Paraguayan companies to formalize depending on their size.
For micro and small businesses, operating formally requires financial and human resources that they do not have, making it a costly and cumbersome process that further limits already low profit margins. For medium-sized firms, for their part, formalization does not derive benefits from association with the public sector which they consider limited, unprofitable and inefficient.
Large firms offer higher levels of formality directly related to the size and characteristics of their operations, but they view it as an obligation that is a penalty on their competitiveness given the little control over informal firms.
There is one element that all companies, no matter their size, agree on: The cost of Social Security is high and the services provided in return represent large gaps in coverage and quality.
The multiple causal relationship of the informal trait indicates that in order to address it, it is necessary to implement a package of policies covering aspects related to both the barriers to the formal trait and the incentives for it. Paraguay, like most countries in the region, has implemented various measures such as facilitating/reducing business creation procedures or designing tax systems.
However, measures that tend to reduce administration costs and taxation were not sufficient by themselves to influence rates of the unregulated trait. Thus, international evidence shows that it is necessary to adopt a comprehensive corporate formalization strategy, adapted to the specifics of each country and its business fabric, taking into account the size, productivity and growth prospects of companies, among other factors.
Measures to simplify procedures and reduce transaction costs should be complemented by business development programs that help improve business productivity, publication and communication campaigns, and measures to enhance compliance with the rules.
Based on these findings, the IDB study proposes four areas of intervention within the framework of a governance and coordination tool that integrates agents from the public and private sectors: 1) adaptation of regulatory frameworks, 2) digitization and use of information and communication technology, 3) business development, and 4) finance and banking.
Similarly, the work raises the need to promote two basic public goods as a cross-sectional axis: 1) increasing the availability of data and information to improve policy design and decision-making in firms and markets (eg, financial); 2) Improve coordination through public and private spaces that generate effective action agendas.
These factors are crucial for this set of isolated measures to form an tailored set of policies and integrate them into a productive development strategy that facilitates breaking the vicious circle of informality and low productivity. Finally, a broader productive development strategy should include policies aimed at enhancing the business environment and programs that allow productive firms to grow and create formal employment opportunities.