Digital payments, informality and economic growth

BIS Working PapersNo 1196 Digital payments, informality and economic growth by Ana Aguilar, Jon Frost, Rafael Guerra, Steven Kaminand Alexandre Tombini Monetary and Economic Department July 2024 JEL classification: G21, G23, O32 Keywords: Digital innovation, informal economy, productivity, economic growth BIS Working Papers are written by members of the Monetary and Economic Department of the Bank for International Settlements, and from time to time by other economists, and are published by the Bank. The papers are on subjects of topical interest and are technical in character. The views expressed in them are those of their authors and not necessarily the views of the BIS. This publication is available on the BIS website (www.bis.org). Digital payments, informality and economic growth Ana Aguilar, Jon Frost, Rafael Guerra, Steven Kamin and Alexandre Tombini1 June 2024 Abstract We examine the relationship between digital payment innovation, economic growthand informal activities in 101 economies over 2014–19. Following the economic growth literature, panel regressions relate growth rates of GDP per capita, total factor productivity (TFP) and the share of informal sector employment to lagged levels of these variables, the extent of digital payments use and various controls for endogeneity. We find that a one-percentage point increase in digital payments use is associated with increases in the growth of GDP per capita of 0.10 percentage points over atwo-year period, and a decline in the share of informal sector employment of 0.06 percentage points over a two-year period. Insofar as the reported share of the population making digital payments ranges nearly from 0 to 100 percent, this is substantial. Digital payments do not appear to be significantly associated with rises in TFP, once controlling for general measures of digitalisation and government effectiveness,but they are linked to greater financial inclusion and credit access. Our results reinforce the case for government policies to encourage digital payments and, as complementary factors, access to the financial sector and information technology. Keywords: digital innovation, informal economy, productivity, economic growth. JEL classification: G21, G23, O32. Introduction One of the most critical developments in global finance in recent years has been the adoption of cutting-edge information technology. Among the many applications offinancial technology (fintech) has been the development of digital payment methods. Digital payments, also known as electronic payments, refer to any transfer of value using digital devices or channels, and include such means as bank transfers, mobile money, quick response (QR) codes and payment instruments such as credit or debit cards and help to avoid the use of cash. Digital payments also encompass theuse of cryptocurrencies, such as bitcoin or so-called stablecoins,2 and central bank digital currencies (CBDCs).3 Although the adoption of digital payments has become quite widespread in advanced economies (AEs), it is advancing as rapidly in emerging market and developing economies (EMDEs). Between 2014 and 2021, the share of adults in developing countries using digital payments rose from 35% to 57%, according to World Bank Findex data. In China, private digital payments platforms such as Alipay and WeChat Pay, based on digital wallets and QR codes, have made substantial inroads into retail cash payments (Klein, 2020). Similarly, the mobile money system M-Pesa, introduced in 2007, has revolutionised retail payments in Kenya, as has the Unified Payments Interface (UPI) in India (Prasad, 2021; Aurazo and Gasmi, 2024). Brazil’s government has developed a retail fast payments system, Pix, that similarly has become widely adopted (Alfonso et al, 2020; Duarte et al, 2022). Finally, it is notable that all of the CBDCs that have become operational to date have been issued by EMDEs: the Bahamas, Eastern Caribbean, Jamaica and Nigeria (Alfonso et al, 2022). Given the proliferation of digital payments in EMDEs, it is natural to ask what role these payments might play in the process of economic growth and development. Thisquestion is of more than purely academic interest. In particular, public policy can importantly affect the pace of adoption of digital payments, both through regulation orencouragement of private payments providers and through direct provision of payments services such as retail fast payment systems or CBDCs.4 Supporters of digital payments, including private providers, argue that their adoption can accelerate economic growth through a number of channels. First, digital payments are cheaper, faster and more efficient than cash or cheques, reducing the deadweight costs of payments to merchants and the economy more generally. As a related matter, they facilitate online purchases, enabling the development of e- commerce (IDB Lab and World Economic Forum, 2022). Second, for large subgroups of the populati