Effect of the Size of the Informal Sector on Economic Growth, Total Factor Productivity and Poverty Alleviation in Kenya
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Date
2020
Authors
Opondo, Mary Awuor
Journal Title
Journal ISSN
Volume Title
Publisher
Kenyatta University
Abstract
The Kenyan economy is predominantly informal. The informal sector employed
132,100 workers in 1974; and 13,442,200 workers in 2016, which translate to 19
percent and 84 percent of the total work force in the respective time periods. The
government has from 1986 put in place policy measures to develop the sector for
employment creation, economic growth, and poverty alleviation. Among the
country‟s Big Four Agenda as contained in the Medium Term Plan (2018-2022), is
the development of the manufacturing sector for economic growth and improved
welfare. The manufacturing sector in the country is largely informal with 80 percent
of firms and 84.3 percent of the total workforce being informal. The development of
the sector is therefore central in the achievement of the country‟s macroeconomic
targets of 10 percent annual economic growth rate and a reduction in poverty rates to
28 percent of the total population by the year 2030. However, theoretical and
empirical literature point at a sector that has low productivity with some studies
attributing poor economic performance to the existence of a large informal sector.
This study aimed at establishing the effect of the size of the informal sector on
economic performance in Kenya. The study objectives were; to analyze the
contribution of the informal sector to output growth in Kenya, to determine the effect
of the informal sector on total factor productivity in Kenya; and to examine the effect
of the informal sector on poverty alleviation in Kenya. The study used secondary time
series data for the period 1974 to 2016 and employed Ordinary Least Squares in
analysis. Data was sourced from the country economic surveys and statistical
abstracts, the Central Bank of Kenya website, the World Development Indicators and
the Global Financial Development database. A growth accounting exercise was
conducted using the standard Cobb-Douglas production function to address the first
objective. The study used the residual from the growth accounting exercise,
commonly referred to as total factor productivity as the dependent variable to address
the second objective based on endogenous growth models with the growth in the
average annual wage in the informal sector as an indicator of the size of the sector
following efficiency-wage theories. The third objective was based on the Marxist and
Liberal theories of poverty. The poverty headcount index was used as the dependent
variable with the depth of informality as an indicator of the size of the informal
sector. From the study findings, the informal sector is the lowest contributor to output
growth in the country; the sector has a negative and statistically significant effect on
total factor productivity; and significantly increases poverty in the country. Based on
the findings, and given the size of the informal sector, the study concludes that there
is a need to target increased productivity in the sector for increased output growth,
increased total factor productivity and poverty alleviation in the country.
Description
A Thesis submitted to the Department of Applied Economics in the School of
Economics in partial fulfillment of the requirements for the award of the degree of
Doctor of Philosophy (Economics) Kenyatta University
Keywords
Economic Growth, Poverty Alleviation, Kenya, Kenyan economy, informal sector, economic performance