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India’s economy and the challenge of informality -R Nagaraj and Radhicka Kapoor

-The Hindu

Policy efforts to formalise the economy will have limited results as the bulk of informal units are petty producers

Since 2016, the Government has made several efforts to formalise the economy. Currency demonetisation, introduction of the Goods and Services Tax (GST), digitalisation of financial transactions and enrolment of informal sector workers on numerous government Internet portals are all meant to encourage the formalisation of the economy. But why the impetus for formalisation? The formal sector is more productive than the informal sector, and formal workers have access to social security benefits.

The above-mentioned efforts are based on the “fiscal perspective” of formalisation. This perspective appears to draw from a strand of thought advanced by some international financial institutions such as the International Monetary Fund, which foregrounds the persistence of the informal sector to excessive state regulation of enterprises and labour which drives genuine economic activity outside the regulatory ambit. It underplays informality as an outcome of structural and historical factors of economic backwardness. Arguably, excessive regulation and taxation ensure the endurance of informal activities. Hence, it is believed that simplifying registration processes, easing rules for business conduct, and lowering the standards of protection of formal sector workers will bring informal enterprises and their workers into the fold of formality.

The fiscal perspective has a long lineage in India going back to tax reforms initiated in the mid-1980s. Early on, in an attempt to promote employment, India protected small enterprises engaged in labour intensive manufacturing by providing them with fiscal concessions and regulating large-scale industry by licensing. Questions of efficiency aside, such measures led to many labour-intensive industries getting diffused into the informal/unorganised sectors.

Further, they led to the formation of dense output and labour market inter-linkages between the informal and formal sectors via sub-contracting and outsourcing arrangements (quite like in labour abundant Asian economies). In the textile industry, the rise of the power looms at the expense of composite mills in the organised sector and handlooms in the unorganised sector best illustrates the policy outcome. While such policy initiatives may have encouraged employment, bringing the enterprises which benefited from the policy into the tax net has been a challenge. The challenge is only partly administrative. Political and economic reasons operating at the regional/local level in a competitive electoral democracy are responsible for this phenomenon, too.

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