Authored By: LUCY TUITAI
THE KENYA SCHOOL OF LAW
INTRODUCTION
Kenya’s economic landscape includes a wide range of participants, from established formal corporations to micro-enterprises and individuals working outside traditional systems of registration and regulation. A significant part of this economic activity takes place within what is broadly referred to as the informal economy. It can be seen in roadside kibandaskis, hawkers and other small-scale traders, domestic and casual work, home-based businesses, and, increasingly, online sellers who operate through digital platforms.
For many individuals and households, the informal economy is not simply an alternative to formal employment or entrepreneurship, but a primary source of income and livelihood. Its scale and integration into everyday life therefore raise a fundamental question: how does an economic sphere so deeply embedded in society continue to operate, to a significant extent, outside the formal structures through which the State ordinarily regulates economic activity?
The question becomes particularly significant when the informal economy is considered against Kenya’s progressively developing legal and policy framework. The state has recognized the importance of micro and small enterprises overtime and adopted measures intended to not only promote their growth but also facilitate formalization and integration into the formal economy. Notwithstanding these efforts and the benefits that would result from the same, informal business remain embedded in Kenya’s economic and social fabric. The resulting tension becomes apparent when this economic reality is viewed in the lens of the law.
It is against this background that this paper examines the formalization paradox in Kenya, with a view to assessing the relationship between the coexistence of a legal ambition and the persistence of informal economic activity. It seeks to determine whether the continued prevalence of informality is a consequence of shortcomings in implementation, the design of the regulatory framework, the rational choices of informal economic actors or a combination of these factors.
THE INFORMAL ECONOMY AND KENYA’S LEGAL FRAMEWORK
For a long time, the informal economy has existed with no proper definition or parameters. Rather it is commonly understood in contrast to the formal economy, with the distinction often turning to the extent to which economic activities are recognized, regulated and protected by formal legal institutions and arrangements. The International Labour Organization (ILO) describes the informal economy broadly as encompassing economic activities undertaken by workers and economic units that are, either in law or in practice, insufficiently covered by formal arrangements. It further recognizes that informality is frequently associated with insecure employment, limited social protection, poor governance and low productivity, particularly where individuals have few viable alternatives for securing their livelihoods.[1] This understanding is important because informality should not be necessarily equated with illegality. An enterprise may operate informally, without every aspect of its activity being unlawful, just as a formally registered business may fail to comply with particular legal requirements.
Kenya does not lack laws and institutions capable of regulating or supporting economic activity. Rather, the legal framework applicable to businesses is extensive and operates at both the national and county levels. Depending on the nature and scale of an enterprise, the regulatory requirements may include business registration, licensing, taxation, public health and safety requirements, employment obligations, consumer protection requirements, standards and sector-specific approvals. Business activities may be conducted through different legal forms, including sole proprietorships, partnerships and companies, while county governments exercise important regulatory functions through trade licensing and other local requirements. A roadside food vendor, for example, may be required to comply with a combination of business licensing, public health, food safety and taxation requirements depending on the nature and location of the activity.
The Constitution of Kenya, 2010 provides an important foundation for understanding the State’s regulation of the informal economy. Although the Constitution does not expressly refer to the “informal sector”, several of its provisions are directly relevant to people who depend on informal economic activities for their livelihoods. Article 41, for instance, protects the right to fair labor practices and is particularly relevant to informal workers who may lack the protections ordinarily associated with formal employment[2]. Article 43 guarantees economic and social rights, including the right to social security, which is significant for informal workers who often operate outside formal systems of employment-based social protection[3]. Article 27 guarantees equality and freedom from discrimination, making it relevant where laws, policies or enforcement practices disproportionately affect people engaged in informal economic activities.[4] Article 10, which sets out the national values and principles of governance, including good governance, transparency, accountability and participation of the people, is equally relevant to how public authorities exercise their regulatory powers over informal businesses and workers. [5]These provisions demonstrate that informal economic actors are not outside the protection of the law simply because their activities fall outside conventional formal structures. More importantly, the Constitution is the supreme law of Kenya, and all persons, State organs and institutions are bound by it. All legislation, policies and administrative measures governing the formalization and regulation of informal economic activity must therefore be consistent with these constitutional standards. Formalization cannot consequently be viewed solely as a process of bringing informal actors within the regulatory system; it must also be pursued within a constitutional framework that protects their rights, livelihoods and dignity.
The Micro and Small Enterprises Act, 2012 represents a more direct legislative response to the challenges facing small enterprises. Among its objectives is the facilitation of formalization and upgrading of informal micro and small enterprises.[6] The establishment of the Micro and Small Enterprises Authority further demonstrates the State’s recognition that small enterprises require a distinct institutional and policy framework.
BARRIERS TO FORMALIZATION
Accordingly, Kenya’s legal position reflects a dual objective. On the one hand, the State seeks to regulate economic activity to protect the public interest, ensure compliance with applicable standards, and generate public revenue. On the other, it seeks to promote and formalize enterprises that operate outside conventional structures. It is this intersection between regulation, promotion and formalization that provides the foundation for the formalization paradox. The question is therefore not simply whether informal businesses are complying with the law. It is whether the legal framework has been sufficiently designed around the circumstances of those whom it seeks to formalize.
As highlighted above, several factors contribute to the continued persistence of informality. Formalization can require an enterprise to navigate several layers of regulatory obligations, each carrying its own financial, administrative and informational demands. For a larger enterprise with established systems and dedicated personnel, such requirements may be manageable. For a small enterprise operating with limited capital, narrow profit margins and few employees, however, the cumulative burden may be considerably more significant. The cost of compliance is therefore a huge factor in inhibiting formalization since it carries both direct and indirect costs including registration fees, licenses, permits, record keeping and time required to obtain and maintain regulatory approvals.
The difficulty is particularly apparent where the informal actor has limited knowledge of the applicable legal requirements or lacks the resources necessary to comply with them. This is further reinforced by the number of procedures and institutions an enterprise must navigate to obtain the requisite registration, licenses and approvals. Where requirements are dispersed across different regulatory bodies or levels of government, compliance may become difficult to understand and administratively burdensome, particularly for enterprises without dedicated personnel or resources to manage regulatory matters. An individual who begins selling food from a roadside stall, for example, may understand the activity primarily as a means of earning a livelihood rather than as an enterprise requiring interaction with multiple regulatory institutions. Requiring such an actor to understand and navigate registration, licensing, taxation, health and safety and other applicable requirements may create barriers that are not necessarily contemplated by the formal regulatory model.
RETHINKING THE REGULATORY APPROACH
The foregoing demonstrates that Kenya’s challenge is not necessarily the absence of a legal framework. Rather, the more fundamental concern is whether the framework adequately accommodates the diversity and realities of informal economic activity. It is clear that the informal sector will always remain an integral part of modern economy. Like many scholars, Mather Chen argues that rather than being a marginal disappearing remnant of traditional economies, the informal economy is a large, permanent and growing feature of modern capitalism closely tied to the processes of growth and capitalism.[7] It attracts people from all walks of life and its persistence suggests that it fulfills significant needs, challenging perspectives that view it solely as a refugee for society’s outcasts.[8] Therefore, effectively regulating a dynamic economy operating across diverse sectors requires a targeted yet structured regulatory approach. In addressing informality, the Government should recognize that regulation affects informal actors in complex ways, since both excessive regulation and a complete absence of regulation can impose costs, meaning the appropriate solution is thoughtful, tailored regulation rather than blanket deregulation or enforcement.[9]
First, the regulatory framework can be fragmented across different areas of law and different levels of government. An informal enterprise may therefore encounter several regulatory requirements without necessarily experiencing them as part of a coherent formalization pathway Government agencies should strengthen coordination between national and county authorities. A more integrated system through which entrepreneurs can identify, obtain and renew the requirements applicable to their businesses would reduce administrative barriers and improve compliance.
It is also important for the government to note that informality is not a binary state but a spectrum, for instance, some operators pay taxes regularly, some do not, some are formally registered without paying taxes and vice versa meaning that several factors play a role in what would be termed as an informal enterprise each frequently diverging from each other.[10] The regulatory needs of a small roadside food vendor are unlikely to be identical to those of a growing online retailer or a small manufacturing enterprise. A uniform approach to formalization may therefore impose disproportionate requirements on enterprises with substantially different capacities and risks.
Third, formalization efforts may place greater emphasis on bringing businesses into the regulatory system than on ensuring that formalization produces meaningful benefits for those businesses. Daffy describes this as a ‘tax morale’ which innately refers to the nexus of laws, law enforcement and the social norms and values.[11] He further argues that a system of people with a low tax morale are, in effect, frustrated and alienated to the point of opting out and the more widely a government is perceived to be indifferent to, and incapable to bettering the lives of its people, the lower the tax morale.[12] Therefore, where formalization is experienced primarily as the acquisition of additional obligations rather than access to tangible opportunities, its attractiveness may be limited. In a survey conducted by the World Bank, it was established that many small enterprises choose to remain informal because of the additional costs and taxes associated with formalization.[13] Conversely, enterprises identified benefits such as increased access to financing as potential incentives for registration, suggesting that many informal firms may be willing to formalize where the perceived benefits outweigh the associated costs.[14] Therefore, formalization should be accompanied by visible and accessible benefits such as access to government procurement opportunities, finance, training, markets, social protection and other support mechanisms which can create positive incentives for enterprises to enter the formal economy.
Finally, the effectiveness of any legal framework depends upon implementation. Addressing the formalization paradox does not necessarily require abandoning formalization as a policy objective. Rather, it calls for a reconsideration of how formalization is pursued. A law may establish sound objectives and mechanisms, but its practical impact depends on accessibility, institutional capacity, coordination, public awareness and consistent enforcement. Regulation however much, is targeted at benefiting the actors of informal economy, will only be able to serve the purpose, if properly enforced.[15] The persistence of informality therefore requires consideration not only of what the law provides on paper but also of how those provisions operate in practice.
Comparative experiences from jurisdictions such as Brazil, South Africa and Ghana may provide useful lessons in this regard. However, such comparisons should be used selectively to identify approaches that may be adaptable to the Kenyan context rather than to assume that models developed elsewhere can simply be transplanted into Kenya.
CONCLUSION
In conclusion, Kenya’s formalization paradox lies in the persistence of an adaptive informal economy alongside a legal framework intended to bring it within formal structures. This persistence cannot be attributed solely to weak enforcement or unwillingness to comply, but reflects the interaction between regulatory burdens, institutional capacity, economic necessity, awareness and the perceived benefits of formalization. Historically, policy towards the informal economy has been based on regulation rather than the adoption of developmental approach.[16]The challenge, therefore, is not simply to create more laws or impose greater compliance, but to develop a framework that is accessible, proportionate and responsive to the realities of those it seeks to formalize. The informal economy is likely to remain a significant feature of Kenya’s economic landscape because of its ability to respond rapidly to everyday needs, changing markets and emerging forms of economic activity; like a vine adapting to the structures around it, it will continue to evolve as those circumstances change. The question is therefore not merely when informality will disappear, but whether Kenya’s legal framework can evolve alongside it, making formalization a process of regulatory adaptation rather than a fixed endpoint.
TABLE OF LEGISLATION
Constitution of Kenya 2010
Micro and Small Enterprises Act 2012 (Act No 55 of 2012)
BIBLIOGRAPHY
Chen MA, ‘Rethinking the Informal Economy: Linkages with the Formal Economy and the Formal Regulatory Environment’ (DESA Working Paper No 46, ST/ESA/2007/DWP/46, United Nations Department of Economic and Social Affairs, July 2007) https://www.econstor.eu/handle/10419/63329 accessed 5 September 2026
DiGiacomo J and Onchaga S, ‘Invisible Livelihood Strategies of Kenya’s Informal Economy’ in Rowe K and Omondi M (eds), Future of Work in the Informal Economy in Kenya (Chapter 4 of 7, TRANSFORM 2024)
Duffy F, ‘Informal Economy’ (EBSCO Research Starters, 2019) https://www.ebsco.com/research-starters/economics/informal-economy accessed 6 September 2026
International Labour Organization, ‘Informal Economy’ https://www.ilo.org/projects-and-partnerships/projects/partnership-improving-prospects-forcibly-displaced-persons-and-host/themes/informal-economy accessed 6 September 2026
Roychowdhury P, ‘Regulation, Enforcement and Informality: An Analysis Based on Selected Countries’ (MPRA Paper No 32150, 2011) https://mpra.ub.uni-muenchen.de/32150/ accessed 5 September 2026
South African Local Economic Development Network and Local Economic Development Network for Africa, ‘Managing Informality: Local Government Practices and Approaches towards the Informal Economy’ (Donor Committee for Enterprise Development 2012) https://www.enterprise-development.org/wp-content/uploads/managing_informality_local_governments_practices_towards_the_informal_economy.pdf accessed 7 September 2026
World Bank, Informal Enterprises in Kenya (World Bank 2016) http://hdl.handle.net/10986/24973 accessed 7 September 2026
[1] The International Labour Organization,‘Informal Economy,’< https://www.ilo.org/projects-and-partnerships/projects/partnership-improving-prospects-forcibly-displaced-persons-and-host/themes/informal-economy > accessed 6 Sep 2026.
[2] Constitution of Kenya 2010, art 41
[3] Constitution of Kenya 2010, art 43
[4] Constitution of Kenya 2010, art 27
[5] Constitution of Kenya 2010, art 10
[6] Micro and Small Enterprises Act 2012 (Act No 55 of 2012)
[7] Martha Alter Chen, ‘Rethinking the Informal Economy: Linkages with the Formal Economy and the Formal Regulatory Environment’ (DESA Working Paper No 46, ST/ESA/2007/DWP/46, United Nations Department of Economic and Social Affairs, July 2007) < https://www.econstor.eu/handle/10419/63329< https://www.econstor.eu/handle/10419/63329 >Accessed on 5th September 2026
[8] Francis Duffy, ‘Informal Economy’ (EBSCO Research Starters, 2019), < https://www.ebsco.com/research-starters/economics/informal-economy > accessed 5 September 2026.
[9] Martha Alter Chen, ‘Rethinking the Informal Economy: Linkages with the Formal Economy and the Formal Regulatory Environment’ (DESA Working Paper No 46, ST/ESA/2007/DWP/46, United Nations Department of Economic and Social Affairs, July 2007) < https://www.econstor.eu/handle/10419/63329< https://www.econstor.eu/handle/10419/63329 >Accessed on 5th September 2026
[10] John DiGiacomo and Sylvia Onchaga, ‘Invisible Livelihood Strategies of Kenya’s Informal Economy’ in Kelley Rowe and Maurice Omondi (eds), Future of Work in the Informal Economy in Kenya (Chapter 4 of 7, TRANSFORM 2024).
[11] Francis Duffy, ‘Informal Economy’ (EBSCO Research Starters, 2019), < https://www.ebsco.com/research-starters/economics/informal-economy > accessed 5 September 2026.
[12] ibid
[13] World Bank, Informal Enterprises in Kenya (World Bank 2016)< http://hdl.handle.net/10986/24973> accessed 7 September 2026.
[14] ibid
[15] Punarjit Roychowdhury, ‘Regulation, Enforcement and Informality: An Analysis Based on Selected Countries’ (MPRA Paper No 32150, 2011) 17< https://mpra.ub.uni-muenchen.de/32150/ > accessed 5 September 2026.
[16] South African Local Economic Development Network and Local Economic Development Network for Africa, ‘Managing Informality; Local Government practices and approaches towards the informal economy,’ (Donor Committee for Enterprise Development 2012).< https://www.enterprise-development.org/wp-content/uploads/managing_informality_local_governments_practices_towards_the_informal_economy.pdf> accessed 7 September 2026.
