Industrial Sector Updates – Industrial Policy, Ease of Doing Business, etc.

From informal to the formal economy: The crooked road


From UPSC perspective, the following things are important :

Prelims level: Share of informal economy in the country's economy.

Mains level: Paper 3- Huge presence of the informal sector in the Indian economy and ways to formalise it.

The article discusses the issues around the informal workforce in the economy. What are the factors responsible for the high informal sector in India? How is this sector responding in times of COVID? Are there some easy solutions to mainstream the informal sector into our formal economy? These are some of the points one should ponder upon while reading this article.

The vulnerability of the informal workforce

  • Developing countries such as India are economically vulnerable to Covid-19 because of the presence of huge informal workforce.

  • Lack of protection: This vast informal workforce, which has no labour, social or health protection, is woefully ill-equipped to cope with the medical and economic shocks of the virus.

The humongous size of the informal economy in India

  • Share of the informal sector: As per Periodic Labour Force Survey, 2017-18, 90.6 per cent of India’s workforce was informally employed.

  • This estimate includes those who are employed in informal enterprises (unincorporated small or unregistered enterprises).

  • It also includes informal workers in the formal sector (workers in the formal sector who are not provided any social security benefits by employers).

  • Take another example: Between 2004-05 and 2017-18, a period when India witnessed rapid economic growth, the share of the informal workforce witnessed only a marginal decline from 93.2 per cent to 90.6 per cent. 

  • Covid effect: Looking ahead, it is likely that informal employment will increase as workers who lose formal jobs during the COVID crisis try to find or create work (by resorting to self-employment) in the informal economy.

  • Also, formal enterprises are likely to continue hiring informal workers as they seek more flexibility and attempt to cut labour costs to cope with the COVID-19 induced economic uncertainty.

Why is the informal more favourable over the formal?

  • The basic reason: necessity to eke out a subsistence living in the absence of alternative employment opportunities.

  • The ‘not so basic’ reasons: Some self-employed persons choose to be in the informal economy voluntarily to avoid registration or taxation.

  • Many are deterred by the costs of formalisation or don’t see much benefit from formalisation.

  • Finally, the phenomenon of informalisation of wage employment in the formal sector is a consequence of formal firms trying to avoid payroll taxes and employer’s contributions to social security or pensions to reduce labour costs.

Some solution to smoothen the crooked road

  • A multi-pronged and comprehensive approach is needed to facilitate the transition.

  • Labour intensive growth: It requires creating more formal jobs through labour-intensive growth so that informal workers can move to these jobs.

  • Registering and taxing informal enterprises: The Indian experience of compelling informal firms to register and become tax compliant through demonetisation and introduction of GST formalised them only in a legal sense.

  • There is a need for increasing productivity of informal enterprises and incomes of the informal workforce by providing them with technical and business skills, infrastructure services, financial services, enterprise support and training to better compete in the markets.

  • Promoting the path to entrepreneurship in the informal economy.

  • Many informal enterprises would welcome efforts to reduce barriers to registration and related transaction costs as they expect to reap the benefits of formalising.

  • Reducing decent work deficit: This requires protecting informal workers by providing them a social protection floor, ensuring a set of basic working conditions (adequate living wages, limits on hours of work and safe and healthy workplaces).

A direct question based on the issue of the informal sector can be asked by the UPSC, for ex- “There is a humongous presence of the informal sector in the Indian economy. What are the factors responsible for this? Suggest ways to transform the informal sector into the formal sector.”


Questions around the role of government and who bears the onus of protecting workers deserve careful consideration in the backdrop of the rising incidence of informal employment in the formal sector and the growth of the gig economy. It is apparent that in our relentless pursuit of economic growth, we have ignored the voices of India’s informal sector for too long.

Back2Basics: What is the informal economy?

  • An informal economy (informal sector or grey economy) is the part of any economy that is neither taxed nor monitored by any form of government.
  • Although the informal sector makes up a significant portion of the economies in developing countries, it is sometimes stigmatized as troublesome and unmanageable.
  • However, the informal sector provides critical economic opportunities for the poor.

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