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Context

The informal economy is a global and pervasive phenomenon.
According to ILO approximately 60 percent of the world’s population participates in the informal sector.

Defining Informal Economy

As the International Labour Organization defined the informal sector in 2002, the informal sector does not include the criminal economy.
While production or employment arrangements in the informal economy may not be strictly legal, the sector produces and distributes legal goods and services.
The informal economy also does not include the reproductive or care economy, which is made up of unpaid domestic work and care activities.
It is part of the market economy, meaning it produces goods and services for sale and profit.

India and informal economy

In developing countries like India, large share of the population typically depends upon the informal economy.
According to Periodic Labour Force Survey over 90 percent of workers in India are informal workers.
Out of these those engaged in rural areas is significantly more than urban areas.

What makes an economy ‘informal’?

The informal sector is largely characterized by several qualities:

Skills gained outside of a formal education
Easy entry (meaning anyone who wishes to join the sector can find some sort of work which will result in cash earnings)
Lack of stable employer-employee relationships
Small scale of operations

What characterizes the informal economy in India?

Workers who participate in the informal economy are typically classified as employed.
The type of work is diverse, particularly in terms of capital invested, technology used, and income generated.
The spectrum ranges from self-employment or unpaid family labour to street vendors.
Most workers in the informal sector do not have access to secure work, benefits, welfare protection, or representation.
Many workers engage in informal ventures by choice, for either economic or non-economic reasons.

What makes informality grow in an economy?

There are three basic views to explain the causes of informality:

Informality due to overt regulation: Informal sector is a reservoir of potentially productive entrepreneurs who are kept out of formality by high regulatory costs, most notably entry regulation.
Informality for profiteering: Informal forms are “parasitic” which are productive enough to survive in the formal sector but choose to remain informal to earn higher profits by not complying with taxes and regulations.
Too unproductive to become formal: Informality is a survival strategy for low-skill individuals, who are too unproductive to ever become formal.

Distribution of Informal Workers

Rural: A large number of informal workers are engaged in farm or agricultural activities.
Urban: Those in urban areas are involved primarily in manufacturing, trade, hotel and restaurant; construction; transport; storage and communications; and finance, business and real estate.

Issues surrounding India’s informal sector

Work hazards: Most industries, especially mining, have inadequate safety and health standards. Environmental hazards are evident in the case of the informal sector.
Irregularities in Wages: The daily wages are below the minimum rate of wages for informal workers.
Long Hours of work: Long hours of work in the unorganised sector beyond the labour and regulatory norms are common in India.
Poverty and Indebtedness: Workers in the unorganised sector had a much higher incidence of poverty than their counterparts in the organised sector.
Inactivity of work: There are many times when a worker cannot be economically active. For instance, due to biological circumstances such as sickness or old age, on account of personal calamities such as an accident or unemployment.
No Social Security Net: There are no social security measures to provide risks coverage and ensure maintenance of basic living standards at times of crises such as unemployment or health issues.

Why does formalization matter?

Livelihood guarantee: Ignoring problems in the informal sector can be costly as it can lead to job and wage losses, higher inflation and even risk the livelihood of migrant workers.
Assuring minimum wages: For instance, following demonetisation, a disproportionately higher number of jobs were created in rural India which isn’t the positive it might seem as wages are 2.5 times lower than in urban India.
Migration control: Informal sector workers suffered far more from the national lockdown in 2020 than their formal sector counterparts. With an inadequate safety net, there were painful accounts of displaced informal workers trying to get back to their rural homes.
Inflation control: India was one of the few countries with high inflation throughout pandemic-stricken 2020. Some of this is likely to be associated with the disruption in informal firms, who in normal times are very active in the production of essential goods like food and textiles.

What does all of this mean for economic growth?

Ans. Formalization can be a double-edged sword

The constructive way to think about this is to differentiate between “forced” and “organic” formalisation.
Formalisation that comes only on the back of external pressure or leads to deep distress in the informal sector, may not be sustainable.
Formalisation that happens on the back of policy changes that help small and informal firms grow over time into medium or larger formal sector firms is more sustainable.

Various policy measures

(1) Labor legislations

The legal initiatives like the Employees State Insurance Act (1948), the Minimum Wages Act (1948), the Coal Mines Provident Funds Act (1948), The Employees Provident Fund Act (1952), the Maternity Benefit Act (1961) and the Contract Labour Act (1970) etc. are important for labour welfare.

(2) National Commission for Enterprises in the Unorganised Sector

India is the first country to set up, a commission named National Commission for Enterprises in the Unorganised Sector (NCEUS) in 2004 to study the problems and challenges being faced by the informal economy.

(3) Govt schemes

The Government of India initiated several poverty-related development schemes which indirectly benefited the urban informal sector since independence. Schemes like the MGNREGA and the Swarna Jayanti Shahri Rozgar Yojana were launched to provide support to the poor who constitute bulk of the informal sector.

(4) Social security legislations

The govt has enacted the Unorganized Workers’ Social Security Act, 2008 in this regard. The government has also launched Atal Pension Yojana, Pradhan Mantri Suraksha Bima Yojana, Pradhan Mantri Jeevan Jyoti Bima Yojana, Rashtriya Swasthya Bima Yojana etc.

(5) Skill development

To take care of the need for skills of workers in the informal economy, the government has started various programs such as the Skill India Mission, Pradhan Mantri Kaushal Vikas Yojana, Deen Dayal Upadhyay Grameen Kaushal Yojana, recognition of prior learning etc.

Way forward

Overhauling labour laws: Labour, as well as tax policies, are key to improving the business environment. Labour regulations have to allow for more flexible work arrangements. Moreover, the right to associate freely should be vigorously protected.
Preventing occupational hazards: Innovative means to prevent occupational accidents and diseases and environmental hazards need to be developed through cost-effective and sustainable measures at the work-site level to allow for capacity-building within the informal sector itself.
Local support: Building-on local institutional support to progressively extend social protection will be critical.
Sensitization: Special attention should be paid to the sensitization of policy makers, municipal authorities and labour inspection services to change their traditional role towards a preventive and promotional approach.
Regulatory ease: In the meantime, steps to promote reforms that are needed to help small businesses grow are critical. For example, lowering the regulatory burden associated with growing firms.
Social protection: The extension of occupational health care to workers in the informal sector should be promoted incorporating occupational health into public health care services at district and local levels and establishing a link between first aid and prevention at the work-site’s level.

Conclusion

India’s informal sector is the backbone of the economy.
The nation’s quality of life hinges on things becoming better for masses of informally employed people.
Over the longer term, the prospects for this group will depend on the progress of policy reforms and economic growth, which are the leading drivers of real wages.