Forcibly formalising economy is killing informal jobs

A million Indians enter the workforce every month, or about half the population of Australia every year. This is India’s ‘demographic dividend’. These youths are supposed to find jobs, earn, save and spend, a process that would pull millions of Indians out of poverty. At least, that is the story that we have been sold over the years. But the theory is not translating into practice.

Consider this: land-owning communities across large parts of the country have been on the streets, protesting, over the last three years. This includes the Marathas of Maharashtra, the Jats of Haryana, the Kapus of Andhra Pradesh and the Patidar Patels of Gujarat.

Why is this happening? The average size of the land farmed by the Indian farmer has fallen over the decades and in 2010-2011, the last time the agriculture census was carried out, stood at 1.16 hectares. In 1970-71, it was 2.82 hectares. This has happened because of the division of land across generations. This fall in farm size has made farming an unviable activity in many parts of the country. That’s why the land-owning castes across the country now want non-farm jobs, and have been protesting for quotas in government jobs.

The trouble is, though, the government does not create jobs anymore. In fact, between January 2006 and January 2014, the number of central government employees went up by just 30,000. Worse, the total number of people working for the public-sector enterprises has actually fallen over the years.

Only three out of five individuals who are looking for a job all through the year are able to find one. In rural India, only one out of two individuals who are looking for a job all through the year is able to find one. This has been the state of things since 2013-14.

What’s more, Indian industry favours expansion through capital, that is, buying more machines and equipment and putting them to work, rather than recruiting more people.

Nikhil Gupta and Madhurima Chowdhury, analysts at Motilal Oswal, have studied data up to 2014-2015 from the Annual Survey of Industries, and based on it conclude that over a period of 35 years up to 2014-2015, the rate of employment in Indian industry has on average increased at just 1.9% a year. In comparison, the capital employed by industry has grown at 14% a year.

Clearly, capital has won the race hands down. Or, in other words, when it comes to Indian industry, machine has won over man, for a while now. Indian corporates like the idea of expanding production and, in the process, their business by installing new machines and equipment, rather than employing more people.

One of the reasons for this is the large number of labour laws that Indian firms need to follow. As economists Jagdish Bhagwati and Arvind Panagariya wrote in India’s Tryst with Destiny: “The costs due to labour legislations rise progressively in discrete steps at seven, 10, 20, 50 and 100 workers. As the firm size rises from six regular workers towards 100, at no point between the two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra costs of satisfying these laws.”

The National Manufacturing Policy of 2011 estimated that, on an average, a manufacturing unit needed to comply with 70 laws and regulations. At the same time, these units sometimes need to file as many as 100 returns a year. This basically ensures that an average Indian firm starts small and continues to remain small. In the process, jobs aren’t created. This is reflected in the fact that close to 85% of Indian apparel firms employ fewer than eight people. As per an Economic Survey estimate, close to 24 jobs can be created in this sector for every Rs 1 lakh in investment. Despite this, firms in this sector continue to remain small.

These are essentially big structural issues, which have been around for a while. But in the recent past, Prime Minister Narendra Modi’s demonetisation, which overnight made 86.4% of the currency in circulation useless, ended up destroying many firms operating in the informal sector. The Goods and Services Tax has now added to this.

These days, the presence of the informal sector is seen as a bad thing because it doesn’t pay its share of taxes to the government. This isn’t totally true. People who work for these firms do spend the money they earn and pay their share of indirect taxes. Also, as the Economic Survey of 2015-2016 pointed out: “The informal sector should… be credited with creating jobs and keeping unemployment low.”

As economist Jim Walker of Asianomics wrote in a research note sometime back: “There is nothing intrinsic that says that the informal economy is a less effective or beneficial source of activity than the formal economy.” This is something that the Modi government needs to understand.

In its quest to collect more taxes, it is working towards destroying large parts of the informal economy, which is a huge part of the Indian economy. Ritika Mankar Mukherjee and Sumit Shekhar of Ambit Capital wrote in a research note: “India’s informal sector is large and labour-intensive. The informal sector accounts for nearly 40% of India’s GDP and employs close to 75% of the Indian labour force.”

This is something the government needs to remember in its bid to forcibly formalise the Indian economy.

(Vivek Kaul is the author of India’s Big Government — The Intrusive State and How It is Hurting Us).