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India’s economy and the challenge of informality

  • IAS NEXT, Lucknow
  • 29, Jan 2022
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Despite witnessing rapid economic growth over the last two decades, 90% of workers in India have remained informally employed, producing about half of GDP.

  • Formal jobs, as per India’s official definition, are those providing at least one social security benefit — such as EPF.
  • Official PLFS data shows that 75% of informal workers are self-employed and casual wage workers with average earnings lower than regular salaried workers. 
  • About half of informal workers are engaged in non-agriculture sectors which spread across urban and rural areas.

Evolution of Informal Sector in India

  • 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
  • Due to inefficiency, 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.
  • 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 into the tax net has been a challenge.
  • Industries thriving without paying taxes are only the tip of the informal sector’s iceberg. What remains hidden is large number of low productivity informal establishments working as household and self-employment units which represent “petty production”. 
  • Survival is perhaps the biggest challenge for most informal workers (and their enterprises), and precarity defines their existence.

Since 2016, the Government has made several efforts to formalise the economy, some of which are:

  • Currency demonetisation
  • Introduction of the Goods and Services Tax (GST)
  • Digitalisation of financial transactions 
  • Enrolment of informal sector workers on numerous government portals 

Why the impetus for formalisation? 

  • The formal sector is more productive than the informal sector
  • Also, it is established that formal workers have access to social security benefits.
  • Pandemic has reversed the progress made in formalisation, hence there is a need to speed up the formalisation process.
    • Research by the SBI recently reported the economy formalised rapidly during the pandemic year of 2020-21, with the informal sector’s GDP share shrinking to less than 20%, from about 50% a few years ago — close to the figure for developed countries.

What factors have led to continuation of informal activities?

  • Excessive state regulation of enterprises and labour.
  • High Taxation
  • Informality is also an outcome of structural and historical factors of economic backwardness.
  • Studies show that informality decreases with economic growth, albeit slowly.
  • In many parts of the developing world, including India, informality has reduced at a very slow pace, manifesting itself most visibly in urban slums, poverty and (open and disguised) unemployment.

What steps needs to be taken to enhance formalisation?

  • 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.
  • Also, the economy will get formalised when informal enterprises (especially those involved in petty production) become more productive through greater capital investment and increased education and skills are imparted to its workers. 
  • A mere registration under numerous official portals will not ensure access to social security, unless there is robust implementation of labour laws.