Essay prompt: Do financial linkages between the formal and informal economy constitute mechanisms of economic inclusion, criminalization, or adverse incorporation? Discuss with reference to a particular type of financial linkage involving the informal economy (micro-credit, remittances, informal economy uses of bitcoin, etc.)

Introduction

The informal economy has become universally acknowledged as a non-peripheral and non-temporary part of the global economy (ILO, 2002). Because of this non-peripheral status, it is intertwined with the formal economy in a series of linkages that range from global value chains to co-production and more. As the conversation necessarily circles around the economy, it is critical to evaluate the financial linkages between the formal and informal economy. These financial ties belie the conditionality of the informal economy’s integration with the formal economy, and reveal whether these linkages are offer inclusion, criminalization, or adverse incorporation.

While the informal economy has a fairly agreed upon central definition of “income generating activities operating outside the regulatory framework of the state” (Meagher, 2013: 1, citing  Castells and Portes 1989), changing conditions for the informal economy complicate what counts as informal. East Asia’s informality rate is established as 50.7%. However, without China, that informality rate drops to 26.6.% (Mehrotra, 2020: 2). Given that China’s rate of youth in informal work is at 86.3% (ibid), this trend line shows no sign of reversing in favor of formality. China’s competitive advantage for growth has largely depended on its informal economy: “state-owned enterprises have reduced formal employment and increased informal/flexible employment in order to cut labor costs since the marketization reform that began in 1978” (Huang, Xue and Wang, 2020: 11). As the Chinese context understands the informal economy as highly intertwined with the formal, it therefore stands to reason that financial linkages between the (in)formal economy are also highly integrative. Recently, a new financial tool has been the object of emphasis for the government and has the potential to concretize the permanence of the informal while simultaneously regulating it with the formal.

The e-CNY is China’s Central Bank Digital Currency (CBDC) — a digital fiat of its renminbi. As the first issued by a major central bank (but not the first national bank—see Ree and IMF African Department, 2021 for a report on Nigeria’s CBDC), it has the opportunity to be a standard setter for other major economies that follow suit (Laskai, 2022). As the rollout for the e-CNY has only begun in the last year (The 2022 Beijing Olympics was the primary public rollout) (ibid), the research on the e-CNY in general is in its nascent stages. This goes double for the e-CNY’s impact and the nature of its linkage to the informal economy. Therefore, this paper will use the debates around inclusion, criminalization, and adverse incorporation explored in class to put forth an educated hypothesis of what the potential impacts of the e-CNY could be on China’s informal economy.

Background on China’s relationship to private digital currency

Large swaths of China’s informal economy and formal economy are nearly cashless at this point due to private digital currencies hosted by WeChat Pay and AliPay. The two platforms combined take a 72% market share of all payment transactions (with the rest comprised of bank transfers (5%), card payments (12%), and cash payments (4%)) (Fintech News Singapore, 2022; PR Web, 2021). People use Alipay or WeChat Pay to purchase goods, order coffee and food delivery, pay electricity bills, book taxis, buy air tickets, make donations, transfer money, and even invest in financial products. (Huang, Wang and Wang, 2020: 2–3). The ubiquity and market penetration rate of these digital payment systems mean that broad swathes of China’s population is already naturalized to this format—including the informal economy.

No easy evidence exists of the official size of China’s informal economy, mainly due to a high degree of blurriness between the formal and the informal economy (See Seventh IMF Statistical Forum, 2019). But a 2018 estimate put China’s informal economy at over half of its population (Qian, 2016, citing ILO, 2018). If we the assumption is that over half of China’s population exists in an informal capacity, and “The proportion of adults using mobile payment in China was as high as 76.9 percent in 2017” (Huang, Wang and Wang, 2020: 3), then there is significant overlap. The scope of these services have gone beyond simple payment and remittance. They are now able to serve other financial inclusion purposes, including loans. AliPay’s parent company, Ant Financial Services, has another finance platform called MyBank, which is able to issue loans to users by evaluating their payment history in AliPay. These companies are uniquely situated to provide credit to the informal economy specifically, given that only 20.8% of adults in China have credit cards as of 2017 (ibid). In addition, traditional banks typically “targeted larger enterprises and local governments with their loans, making it difficult for households or small businesses to gain access to credit” (Ong, 2012, cited in Loubere, 2017: 9). Therefore a credit record for loans has historically been a barrier for financial inclusion. With MyBank, as of 2019, it took “three minutes, zero bankers” to issue a loan, and default rates were as low as 1% (Bloomberg News, 2019). This service impacted for many households’ and small and micro enterprises’ (SME) access to credit in China. 

“China's fintech industry is dominated by a number of unicorn Internet companies. Although this has been helpful for promoting financial inclusion, it also complicates the task of financial regulation” (ibid:16). The degree of use and permeation across China’s population motivates regulatory bodies to insert themselves in order to maintain oversight over the financial behavior of its citizenry. Enter the e-CNY.

Central bank digital currency and China’s informal economy

Given that the e-CNY is the digital equivalent of cash, it is backed and stabilized by the People’s Bank of China. It is centralized and not operated on blockchain, meaning it is not a cryptocurrency. When users open a digital e-CNY wallet, they can only acquire e-CNY via affiliation through seven banks—two of which are incidentally WeBank, affiliated with WeChat Pay, and the aforementioned MyBank, affiliated with AliPay (Huld, 2022). For the most part, this  does require users to have a bank account, which might limit access to the e-CNY for the informal economy. However, China has one of the most widely banked populations in the developing world, and not just by numbers, but by ratio. “Nearly eight in 10 adults (79 percent) in China now have a bank account…quickly closing the gap with high-income countries…where 94 percent of adults have bank accounts compared with 53 percent in developing countries” (Consultative Group to Assist the Poor, 2015). This includes “two-thirds of the poorest quintile in China now have a formal account” (ibid). China has also prioritized making banking more accessible by delivering a “Notice on Optimizing Bank Account Opening Services to Effectively Solve the "Difficulty in Applying for Cards" for the Masses and "Difficulty in Opening Accounts" for Small and Micro Enterprises” (China Banking and Insurance Regulatory Commission Office, 2021). The timing of this notice, which was announced December of 2021, was aligned with the public launch of the e-CNY with the 2022 Winter Olympics.

One of the primary motivations for China’s developing this CBDC is as follows. Regulating authorities in China wanted more oversight and visibility into the digital transaction market than social media dominated payments could provide. The Seventh IMF Statistical Forum report (2019) stated that when it came to China’s ability to measure its informal economy, the obfuscating qualities of social media payments meant it would “challenge the accounting of the informal economy” (9). Therefore, it sought to develop a “cash-like digital payment method: accessible to all, low cost, anonymous (to a certain extent), and which facilitates competition among payment service providers” (Deutsche Bank, 2021).

That ‘anonymous (to a certain extent)’ gets at the crux of the intent for the People’s Bank of China. A Visa Inc. report commented that “because cash makes it easier to hide informal activities from authorities, the informal economy will weaken as digital payments become more common and displace cash” (Schneider, Visa Inc. and A.T. Kearney, 2016). Even thought the e-CNY is a cash equivalent, it is essentially fulfilling this purpose. 可控匿名 [kěkòng nìmíng] which translates to ‘controllable anonymity’ is the guiding principle for the People’s Bank of China. The most anonymous option for users is a phone-number-only account, which doesn’t require a bank account associated, but has a one-time transaction limit of ¥2000 (roughly $300 as of May 2022) (MacKinnon, 2022). Even then, it’s not entirely anonymous: all active phone numbers must be tied to a government ID (Huld, 2022). That said, the director of digital currency at the People’s Bank of China said that cell carriers were prevented from providing identifying information to third parties—which includes the People’s Bank of China (MacKinnon, 2022).

As of now, the e-CNY’s permeation of the market remains low due to it still being in the rollout phase. It is optioned in 23 cities—up from the initial pilot 10 (Huld, 2022)—and as of October 2021 had about 140 million registered users (ibid). But the People’s Bank of China has the long game in mind, and is positioned to the influence policy to potentially make the e-CNY a dominant contender for China’s mobile money market (Kumar, 2022).

Positive inclusion leading to future adverse incorporation: issues of linkage and visibility

Linkages are “mechanisms for for mapping, tapping, vesting or contesting the distribution of resources, power and legitimacy between the formal and informal economies” (Meagher, 2013: 1). In the debates around whether digital financial linkages serve the purpose of inclusion, criminalization, or adverse incorporation, a decent amount of evidence would seem to point toward positive inclusion for the informal economy. Other digital fiat currencies, like Nigeria’s eNira serve similar purported goals as the eCNY, including: 1) Increasing financial inclusion 2) Facilitate remittances 3) Reduce informality (Ree and IMF African Department, 2021). Digital payment systems like M-Pesa in Kenya have demonstrated results that supported SME growth rates as well as cash circulation as a whole (Huang, Wang and Wang, 2020: 8). Lowering the transaction cost of remittances via these digital payments has a positive effect on the informal economy in terms of risk management and entrepreneurial activity (ibid: 9). In the case of digital fiat currencies, they reduce or remove the transaction cost of cash (the need to transact in person; the need for withdrawal which is less accessible in rural places or depending on bank affiliation, which typically affects the informal economy) (Mancini Griffoli et al., 2018). With the e-CNY specifically, it offers (theoretically) a greater degree of anonymity than current market dominators AliPay and WeChat Pay as it doesn’t require a government ID tied to accounts for small transactions (MacKinnon, 2022). This also offers as well as greater protection to “make double-spending, illegal duplication and counterfeit, transaction falsification, and repudiation unfeasible” (People’s Bank of China, 2021, cited in Huld, 2022). So would China’s CBDC actually be an example of positive inclusion for the informal economy?

One consideration is that many current evaluations of CBDCs come from “issuer or banking perspectives, with less attention paid to user sides” (Oh and Zhang, 2020: 2). In the early stages of both CBDC research and e-CNY literature specifically, user perspectives are less prevalent. We’ve learned that bank-side perspectives tend to align with the voluntarist perspective, that favor a formalized economy and see the informal economy as a consequence of people specifically looking to evade taxation, regulation, and oversight by organizational bodies like the government (Chen, 2012 cited in Dell’Anno, 2021:14). Despite trepidations around China’s growing prominence in the digital financial space from other countries (Chorzempa, 2021), “the reaction to China’s Internet finance boom has been largely uncritical and depicted in positive terms” (Loubere, 2017: 10). A voluntarist perspective might bias institutions in favor of financial linkages like CBDCs and the e-CNY because of its ability to instill a greater degree of oversight into the informal economy. Since CBDCs are perceived as formalizing, they are also lauded for their increased ability to detect informal incomes (Oh and Zhang, 2020: 3). With that in mind, while perhaps marketed (and interpreted by some) as a harbinger of benefic inclusion, here are three ways that the e-CNY could end up looking a lot more like adverse incorporation in the long term.

The bias of inclusion stemming from microfinance

Given the aforementioned theoretical perspective of banking and formal finance entities, it is safe to say that there is a bias towards inclusion of the informal economy. However, it begs the question of whether inclusion is inherently beneficial. The idea of inclusion as the one and only way for bottom up (i.e. informal-driven) socioeconomic development (Loubere, 2017: 10) can be seen as a fallacy given that it is inherently tied up with the proliferation of microfinance in the 2000s (ibid). The theoretical basis of microfinance is unfortunately enabling of the idea that the poor are responsible for their own misfortune (ibid: 15); if the poor (in this case, the Chinese urban unregistered and therefore informal) are given the opportunity to access financial opportunity through the e-CNY, then there’s no good reason for the informal to be poor since they were afforded the opportunity. It’s a catch 22—and it shifts the onus of poverty onto the individual or the SME.

Risk sharing among the informal economy instead of risk responsibility of the state

“Although recent statistical data suggests that the informal sector has provided the majority of new urban jobs in China since 2010, most of these workers are not enrolled in or protected by the country’s social insurance scheme” (Qian, 2019). Qian (2019) goes on to say that pension schemes and other social insurance benefits are targeted only at formal workers, who are often at SOEs, and therefore leave out the majority of urban workers. One of the measured effects of digital payments and CBDCs are their ability to serve as informal insurance and a mode of risk sharing (Jack and Suri, 2014; Riley, 2018). In Riley (2018), she detailed how mobile money users in Tanzania were able to smooth the effects of a rainfall shock, and their consumption levels did not dip. This had no spillover effect to the rest of the village, showing that users, and users alone, benefitted from this type of risk sharing and informal insurance. Huang, Xue, and Wang (2020) quantitatively demonstrated that this is also the case in urban China: “The empirical analysis in this study show that mobile payments significantly improve risk-sharing among individuals, which is particularly important in a society where there are massive numbers of [informal] migrant workers” (16).  In the short term, this risk-sharing is beneficial to the informal economy as a smoothing tactic for informal households and SMEs. In the long term, it looks like there could be a potential consequence of the state trying to shift the responsibility of social protection onto informal individuals themselves. “it serves to relocate the locus of developmental responsibility to the poor themselves” (Bateman 2015:16-17, cited in Loubere, 2017: 15).


Traceability and social credit ambitions

One major critique of China’s digital financial inclusion comes from Loubere (2017). Although they are referring to the digital payment environment of China in general, as the paper is written before the e-CNY’s roll out, one can imagine that their arguments go double for a digital payment platform developed by the state itself for its own CBDC: “digital financial inclusion can be seen as a key element in a wider project of expanding surveillance through big data in order to close down spaces for those seeking to contest the hegemonic socioeconomic order” (ibid: 9). China’s vague but near-universally opposed idea of a social credit system (ibid: 15) would undeniably be integrated with the e-CNY, as it is run by the state-overseen People’s Bank of China. Although the service could provide more anonymous financial services than MyBank and WeBank, since it only requires a phone number for small transactions and the others require government IDs, it would likely be with the long-term goal of integrating data from the e-CNY with the individual social credit evaluations, therefore “serv[ing] to reproduce patterns of inequality and exploitation” (ibid: 9). Therefore, the e-CNY could be interpreted as a long-game tool to incorporate the informal by allowing them greater ‘anonymity’ than the competitors while intending to use the information generated by transactions to potentially criminalize the individual via its social credit.

Conclusion: e-CNY: By the state, for the state

The e-CNY is a win-win-win solution for the state: it would amplify China’s prominence in the digital finance space “without diminishing the roles of banks and other financial institutions” (Ree and IMF African Department, 2021). It could pass the buck of social responsibility and risk management from the state and formal employment to the individual and informal networks. The data generated by spending and financial activity data that is currently under the purview of the duopoly AliPay and WeChat Pay could be gained by the People’s Bank of China instead, which will enable the state to make decisions about its informal citizenry that could enable future penalties around China’s social credit system. The main question on everyone’s minds is whether the e-CNY will be adopted by the population given that alternatives like AliPay and WeChat Pay are already dispersed among the majority of digital payment users. But with the strong arm of policy at its disposal, an already-existent digital financial nativeness by the Chinese population—formal and informal alike—and both major competitors agreeing to accept it on their platforms, it seems like it would be hard-pressed to fail in the long run. This will inevitably have serious consequences for China’s informal economy.

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