Big claims of rapid economic formalization are suspect

News: The formalization of India’s economy has increased over the years, but regaining a fast-growth trajectory is a challenge yet to be fully tackled.

What is the size of India’s informal economy?

Estimate done in 2018 suggests the size of the informal economy at 52%. This number was expressed by NSC (National Statistical Commission) with very limited methodological details.

How the size of informal economy can be measured?

e-Shram initiative: GoI is making earnest efforts to bring such unorganised employment into the formal stream by incorporating MSMEs through the GST portal. It also recently launched the e-Shram initiative that is creating a comprehensive database of unorganised employment in India.

Digital footprints: the consumption of the informal sector can be captured through digital footprints. For instance, an informal wage-earner’s trace in the economy may be captured by the shampoo-sachet or glucose biscuit she may be purchasing. Likewise, a small entity may be a seller in an online platform and accepting UPI-based payments.

What are the signs that indicate an increase in formalization of the economy?

Provident-fund enrolments have steadily risen amid a job scarcity – a chunk of these could be due to payrolls going formal.

Extra bounce seen lately in collections of GST.

Inc in UPI transactions: In October, transactions done via the Unified Payments Interface (UPI) hit a record 4 billion, worth over $100 billion.

The EPFO portal shows that around 2.25 lakh business units have been formalised since that data has been made online.

The total number of outstanding KCCs (Kisan Credit Cards) is currently at 6.5 crore. The credit offtake per KCC translates into agri-credit formalisation of Rs 4.6 lakh crore.

What are the issues that still remain?

As a proportion of gross domestic product, cash in circulation has risen above its level before demonetization.

The extent of formalization still lacks a sound estimate. Recent research work by State Bank of India estimated that the informal sector’s share of India’s output had shrunk from over half the total back in 2017-18 to under a fifth. The way this fraction was arrived at, however, does not lend it the reliability needed for such an important ratio.

Has there been a considerable decrease in the size of the informal economy?

A recent report by SBI made a striking claim that the informal sector’s share in India’s GDP has shrunk from about 52% three years ago to a “max 15-20%” of GDP.

There are four key problems with this analysis.

Firstly, the assumption that the entire GDP loss in 2020-21 represents the loss of just the informal sector is too simplistic. The informal sector was undoubtedly hard hit. But given the widespread evidence of revenue losses suffered by the formal sector, it is hard to justify the assumption of zero loss in the formal sector.

Secondly, SBI’s analysis uses an extraordinary reference point (the pandemic year) to make a claim about a structural transformation in the economy.This is a problematic approach. Small enterprises fold easily when faced with external shocks, be they pandemics or droughts. Compared to large firms, they are also easier to restart once the shock subsides.

Thirdly, SBI’s report makes an implicit assumption that the reported GDP figures capture the informal sector’s contribution accurately. To calculate growth of the informal sector, national account statisticians use the available data on formal-sector indicators for each sub-sector of the economy (with some exceptions such as agriculture) i.e. they make assumptions for informal sector.

Fourthly, share of workers with social security benefits is also considered to estimate the extent of formalization across the world. In India, such data is now available annually, via the periodic labour force surveys (PLFS). As per the survey an overwhelming majority of workers in India do not have regular employment. Even among the small minority that have regular jobs, a majority don’t have a written contract or paid leave, according to the last pre-pandemic PLFS survey conducted in 2018-19.

Source: This post is based on the following articles:

‘Gains of demonetization and worries over growth‘ and ‘Big claims of rapid economic formalization are suspect‘ published in Livemint on 9th Nov 21;

‘Who shrunk India’s informal sector?‘ published in TOI on 9th Nov 21.