From UPSC perspective, the following things are important :
Prelims level : Not much
Mains level : Paper 3- Pros and cons of formalising the informal sector, policy changes needed to support the informal sector
Attempt to formalise the informal sector would not necessarily benefit it as two recent papers reveal.
What do the research papers reveal?
- The first paper-No strong evidence that formalisation improves business outcomes.
- Published by the National Bureau of Economic Research, economist Seema Jayachandran argues that there is no strong evidence from studies conducted in many developing countries that formalisation improves business outcomes.
- The second article-Formalisation an evolutionary process:
- In the second article, a background paper for the International Labour Organisation (ILO), economist Santosh Mehrotra calls formalisation an evolutionary process.
- During this evolutionary process small, informal enterprises learn the capabilities required to operate in a more formal, global economy.
- He says they cannot be forced to formalise.
The formalisation trap
- Why does the state want to formalise?
- Easy monitoring and taxation: The state finds it easier to monitor and to tax the firms that adopt its version of formality.
- Reduced last-mile cost for banks: Formality can reduce the last-mile costs for banks also.
- Problem with the imposed formalisation
- The added cost outweighs benefits: Ms Jayachandran’s study reveals that most of the formalities imposed from above, add to the costs of the firms that outweigh the benefits of inappropriate formalisation.
How informal sector improves themselves?
- Association with their peers: Small entrepreneurs gain from forming effective associations with their peers.
- Mentoring: They also benefit greatly from ‘mentoring’.
- On job skill development: Skills of small entrepreneurs and their employees are best developed on-the-job.
- This is because they cannot afford the loss of income by taking time off for training.
- Soft skills to form associations and manage enterprises, matter as much for the success of the enterprises as ‘hard’ resources of finance and facilities.
Problems with connecting to global supply chains-
- There is a desire to connect small firms in India more firmly with global supply chains.
- Search for lover cost source supply: Mehrotra points out that the primary motivation of multinational companies for expanding their global supply chains is to tap into lower-cost sources of supply.
- Supply chains compete with each other.
- When wages and costs increase in their source countries, they look for other lower-cost sources.
- Informal-the lowest labour cost firms: The lowest labour cost firms at the end of supply chains are generally informal.
- Thus, the push by the state to formalise firms is countered by the supply chain’s drive to lower its costs.
- India’s jobs, incomes, and growth challenges necessitate a reorientation of policies towards the informal sector.
- First-The government and its policy advisers must stop trying to reduce its size.
- The development of an economy, from agriculture to the production of more complex products in the industry, is a process of learning.
- Informal enterprises provide the transition space for people who have insufficient skills and assets to join the formal sector.
- Second-Policymakers must learn to support informal enterprises on their own terms.
- Merely making it easy for MNCs and large companies to invest will not increase the growth of the economy.
- Third-Find ways to speed up the process of learning.
- Policymakers must learn how to speed up the process of learning within informal enterprises by developing their ‘soft’ skills.
- Large schemes to provide enterprises with hard resources such as money and buildings, which the government finds easier to organise, are necessary but inadequate for the growth of small enterprises.
- Fourth-Networks and clusters of small enterprises must be strengthened.
- They improve the efficiency of small firms by enabling sharing of resources.
- More clout to negotiate: They give them more clout to improve the terms of trade in their favour within supply chains.
- Reduced last-mile cost: They reduce the ‘last mile costs’ for agencies and providers of finance and other inputs to reach scattered and tiny enterprises.
- Fifth-The drumbeat for labour reforms must be changed.
- The laws should be simplified, and their administration improved. And, their thrust should be to improve the conditions of workers.
- Finally- The social security framework for all citizens must be strengthened.
- Health insurance and the availability of health services must be improved.
- And disability benefits and old-age pensions must be enhanced.
- The purpose of ‘labour reforms’ must be changed to provide safety nets, rather than make the workers’ lives even more precarious with misdirected attempts to increase flexibility.