Navigating the Governance Gap: Is Africa's Informal Sector Holding Back Economic Transformation?

Understanding how the proliferation of informal economic activities influences Africa's transformation efforts is gaining popularity. Yet, empirical evidence documenting the informality‐led structural transformation lag remains scarce. In this paper, we examined the impact of informality on African transformation while accounting for the moderating role of governance. We used a novel dataset on Africa's economic transformation sourced from the African Centre for Economic Transformation from 2000 to 2018 for 24 African countries. Estimations were done using fixed effects and instrumental variables with high‐dimensional fixed effects (IV‐HDFE) techniques, which account for bias from omitted variables and endogeneity problems. Two key findings emerged from our analysis. First, we found that informality has a significant negative impact on African economic transformation. Secondly, we found that when interacting with governance, the effects of informality on economic transformation become positive, thus showing that effective governance attenuates the negative impact of informality on economic transformation in Africa. These findings are robust to various estimations and sample splitting and have important implications for policy on African structural transformation. We concluded by emphasising the importance of government effectiveness for economic transformation in the face of high informality on the continent.