Forced formalisation will push informal sector underground

In the aftermath of demonetisation and Goods and Service Tax (GST), the informal sector has been a topic of much debate. It is therefore imperative to understand the nature of the informal sector, especially the rural informal sector and clear misconceptions that exist in popular perception about it. Reliable statistics about the nature of the informal sector are difficult to find. The reports by the National Sample Survey Organisation (NSSO) are the closest official estimates available and these offer fascinating insights.

The rural informal sector is not a homogenous category. Rather it consists of innumerable micro or small enterprises involved in diverse economic activities. The common features of these enterprises are that most of them operate with small amounts of capital, a majority are family-owned, often unregistered with any government agency, and mostly use family labour. Only about 10% of these unincorporated enterprises hire outside help. Their ability to survive is often due to their ability to use family labour for long hours. In terms of the number of hired hands, the rural and urban enterprises are almost similar in terms of employment provided to males and females. A major point of departure is that in rural areas, women hired as helpers are double the number of men.

An overwhelming number of these enterprises (96%) operate as proprietary concerns. The occasional partnership is often within the same household. In rural areas, industries (35.1%) are more than trade (33.5%) and other services (31.4%) while in urban areas, trade (39.8%) and other services (33.5%) dominate over the industry (26.7%). It is safe to assume that these enterprises do not have access to institutional funds or other benefits that are available to the larger, formal enterprises.

A common misconception is that the informal sector has declined in the past decade due to a combination of policy interventions, the spread of technology, and the rapid growth in the formal sector. This perception stems from a comparison with the growth in the formal sector, which has expanded into areas that were hitherto the domain of the informal sector. However, the reality is that in this decade (before Demonetisation and GST), the informal sector grew by about 9% on average. The estimated number of unincorporated economic enterprises in rural and urban areas has grown from 5.767 crore in 2010 to about 6.339 crore by 2016, while the number of workers dependent on these enterprises rose from 10.797 crore to 11.127 crore. Interestingly, though the number of rural enterprises has increased, the number of workers dependent on them has declined: from 3.089 crore units with 5.318 crore workers to 3.248 crore units with 4.986 crore workers.

Employment provided by these rural informal enterprises is dominated by a few sectors. The average emoluments in rural areas increased from Rs 36,354 to Rs 74,781 per worker over the same period. In the case of rural manufacturing enterprises, nearly 75% of the employment is provided by the five sectors related to food products, tobacco, textiles and apparel, along with wood and wood products. In the case of trade, motor vehicle-related businesses and wholesale trade account for most of the employment. In the case of other services, nearly 81% of the employment is provided by five sectors -- community services, land transportation, food-related, education and rural financial services (mostly intermediation related to self-help groups). The growth in these enterprises is more clearly discernible in the rural Gross Value Addition (GVA), which measures the value of goods and services produced less the cost of all inputs to produce them, increased from Rs 1,03,037 crore to Rs 3,44,551 crore from 2010 to 2016 across the three sectors -- manufacturing, trade and services.

The GVA growth rate was higher in the rural areas than in the urban areas where it increased from Rs 3,19,083 crore to Rs 8,07,786 crore during the same period. The rural and urban enterprises are a study in contrast: rural enterprises witnessed a GVA increase in rural manufacturing and trade but declined in services over 2010 to 2016. In contrast, the GVA of trade increased in urban areas while those of manufacturing and other services decreased in the period.

Impact in changing context

In this changing context, formalisation-related policy interventions including Demonetisation, encouraging digital payments, and spread of banking and GST have immense implications for informal enterprises, especially in the rural areas where these provide livelihoods to about 2.24 crore households out of the 16.8 crore rural households. The notion that large parts of the economy can be formalised is impractical in a large and diverse country like India. Though a degree of formalisation may expand the market for the formal sector, the gains are likely to be limited. There are some parts of the rural economy which cannot be formalised due to its inherent nature. In the past decade, the rural economy has witnessed rapid formalisation of certain spheres while in other spheres it has witnessed rapid informalisation. An example illustrates these changes in rural areas. A large part of the transportation sector in the rural areas has witnessed the withdrawal of the formal state-owned public sector transportation and its supplanting by informal providers. Little wonder that ‘land transportation’ is the second largest employer in the rural sector after government-funded community services.

The thriving informal enterprise in most parts of the rural economy is because over the years these enterprises have learnt to operate in market spaces that are not profitable for the larger formal enterprises or have learnt to create new niche markets for themselves -- which are too small, unprofitable or require high levels of personalisation. Informal finance in rural areas, especially small pawn-brokers are good examples of how providers have learnt to operate in competitive areas like lending against gold. The forced push towards formalisation through disruptive policy interventions is likely to cause more long-term damage rather than dramatically increase formalisation. History is replete with examples where attempts at formalisation have instead ended with the creation of a dynamic underground economy. In contrast, gradual interventions to formalise the economy, like in Peru, have had more long-lasting success.

(The writer is an independent researcher based in Andhra Pradesh)