Understanding why the informal sector really shrank during the pandemic

News: Increase in formalisation is not a consequence of micro and small informal firms transitioning to formality.

A recent study by SBI estimates that the share of the informal economy has fallen to a mere one-fifth of GDP — a figure comparable to many advanced economies.

However, the supposed formalisation that happened during the pandemic is mainly an outcome of shrinkage of the informal sector under extreme duress.

Understanding the basic difference between formalisation and infomalisation and the objectives of formalisation will help us to understand this issue better.

What are the basic differences between formalisation and infomalisation?

As per ILO, the Informal sector includes those industries that are;

-Private unincorporated enterprises owned by individuals (or households) that are not constituted as separate legal entities independently of their owners.

– For which no complete accounts are available.

– Not registered under specific national legislation (such as Factories’ or Commercial Acts).

Formal workers in India are defined as those having access to at least one social security benefit such as a provident fund or healthcare benefits.

What are the basic objectives of formalisation?

Transitioning to formality requires a reduction in dualism in production and an improvement in employment quality.

Formalisation is not simply about legal considerations. Importantly, it is about increasing their productivity.

The final objective of formalisation is to improve the working and living conditions of those in the informal economy.

Hence,  formalisation does not simply mean registration on a portal(E-shram), it includes a development strategy that requires stepping up investment in physical and human capital to boost productivity and the extension of social security benefits for all workers.

Why the formalisation during the pandemic cannot be counted as a transition to formality?

Firstly, a decline in the share of informal sectors GDP cannot be accounted for as formalisation. Because the informal sector, which was badly affected by the economic contraction during 2020-21, didn’t receive much policy support. Most of the supply-side measures were mainly focused on firms in the formal sector.

Secondly, a decline in the informal sector’s share in GDP has not been accompanied by an expected reduction in its employment share. For instance, the PLFS survey shows, the employment share in non-agricultural informal enterprises has increased from 68 percent in 2017-18 to 69.5 percent in 2019-20.

Lastly, just registering firms cannot be counted as formalization.

Source: This post is based on the article “Understanding why the informal sector really shrank during the pandemic” published in Indian Express on 18th November 2021.