Challenge of Informality in Indian Economy – UPSC GS3

Definition of Informality:
  • The enterprises that are not formed as distinct legal organisations and for which no comprehensive records are available are classified as informal enterprises by the International Labour Organization’s (ILO) 15th International Conference of Labour Statisticians.
  • Informal employees were classified as individuals who did not have access to social security during the 17th Conference of ILO.
Informality in India:
  • Despite rapid economic growth over the last two decades, the share of formal workers in India stood at a mere 9.7% (47.5 million).
  •  Even now, around 90% of workers in India are informally employed.
  • 75% of informal workers are self-employed with earnings lower than salaried workers.
  • About half of informal workers are engaged in non-agriculture sectors spread across urban and rural areas.
Challenges posed by informality:
  • Underdevelopment:
    • According to the ‘Informality and Development’ study, the persistence of informality is a sign of underdevelopment.
    • Across countries, there is a negative correlation between informality and per capita income.
    • The persistence of a high share of informal employment in total employment is nothing but lack of adequate growth or underdevelopment.
  • Low productivity:
    • Workers lack access to quality education, skill training. This along with the use of obsolete technology and tools results in low productivity in informal enterprises.
  • Lack of social security:
    • People working in the informal sector lack access to social security.
    • Survival is the biggest challenge for most informal workers. The pandemic further exacerbated this challenge. Recent reports suggest that the informal sector’s GDP share reduced to less than 20%, from 50% a few years ago.
IMF’s take on informal economy:
  • This perspective is based on the thought of the International Monetary Fund, which regards the existence of the informal sector to excessive regulation of enterprises and labour that results in economic activity outside the regulatory purview. Excessive regulations and taxation ensure the endurance of informal activities.
  • It notes that informality is because of structural and historical factors of backwardness.
  • It is believed that registration processes, easing rules for business conduct, and lowering the standards of protection of formal sector workers will formalize informal enterprises.
Factors affecting informalization in Indian Economy:
  • To promote employment, India protected small enterprises engaged in labour-intensive manufacturing by providing fiscal concessions and regulated large industries by licensing.
  • Such measures resulted in labour-intensive industries getting diffused into the informal/unorganised sectors.
  • While such policy encouraged employment, bringing the enterprises that benefited from the policy into the tax net has been a challenge.
  • Besides administrative reasons, political and economic reasons operating at the local level further aggravated the challenge.
Need of Structural transformation:
  • The movement of low-productivity informal sector workers to the formal or organised sector is known as structural transformation.
  • East Asia saw rapid structural change in the 20th century as poor agrarian economies rapidly industrialised.
  • In many developing countries including India, informality has reduced at a slow pace, showing signs of poverty and unemployment.
Initiatives taken in India to tackle informality:
  • The fiscal perspective has been used in India since the tax reforms in the mid-1980s.
  • The fiscal perspective of formalisation includes efforts like demonetisation, the introduction of the Goods and Services Tax (GST), digitalisation of transactions and enrolment of informal sector workers on government portals.
  • These steps are meant to encourage the formalisation of the economy.
Challenges in tackling informality:
  • Despite the efforts at formalisation, the challenge of informality looms large for India.
  • The challenges of informality are multi-layered. Industries thriving without paying taxes are only visible but a large number of informal establishments working as households and self-employment units with meagre production remain hidden.
  • The lack of digital literacy among some sections of the population poses a hindrance to the digitalisation of transactions.
Way forward:
  • Policy efforts directed at the structural transformation of the informal sector into the fold of formality by alleviating legal and regulatory hurdles are laudable.
  • There is a need to extend these initiatives to the bulk of the informal units that include self-employed and casual workers struggling for existence due to minimal resources.
  • There is a need for greater capital investment and increased education and skills being imparted to the workers.
  • For the economy to get formalised, the focus needs to be given to improving the production facilities as the continuation of informality is due to under-development.
  • Stringent implementation of labour laws is required along with diligent registration of informal workers under official portals to ensure access to social security.

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