Expert Speak India Matters
Published on Oct 15, 2020

The pandemic will bring in more of the unorganised sector in the formal fold by means of the economic stimulus announced, and increase the government’s revenues from indirect taxes in the long-run.

Covid-19: An opportunity to redesign India’s formal-informal economy dynamics

The pandemic, among many things, has also exposed one of the most crucial vulnerabilities of the Indian economy to the world, its large informal sector and the state of the labour working in it. According to an estimate by the International Labour Organisation (ILO), nearly 40 crore informal sector worker have delved deeper into poverty amidst this pandemic. The GDP contraction of -23.9% in the formal sector also depicts a slowdown story which could be much worse in the unorganised informal economy, considered to be the worst affected. This has opened a can of worms, questioning the role of these workers in India’s growth story. Urban India is highly dependent on the informal rural workforce that migrates to cities in search of livelihood and helps build these ever-expanding cities. While the informal workforce contributes significantly to creating and building our cities, there work continues to be undocumented. This has led to the desperate run of the migrant labours from the cities to their respective villages in the last few months as the lockdown swept in. The suffering caused to the labour meant they had no savings, no housing, no access to healthcare and probably no access to the welfare schemes run by the government of India for all these years of their employment.

"The only plausible way to continue operations is through access to liquidity which seems possible only by availing the economic stimulus package announced by the Indian government."

The challenges of the informal economy are not new. But what is interesting is the opportunity and the urgency that the ongoing pandemic has offered the government to formalise the informal sector. The pandemic has put the informal sector enterprises in a position where the cost of registration seems much lower compared to the benefits which they will receive in terms of access to finance and liquidity from the government in such troubled times. This is due to the fact that the lockdown has severely impacted the informal sector and there is no money in the hands of these small enterprises to continue their operations. The only plausible way to continue operations is through access to liquidity which seems possible only by availing the economic stimulus package announced by the Indian government. However, to avail the benefits of these schemes, these enterprises will have to get registered by default. Thus, the pandemic will bring in more of the unorganised sector in the formal fold by means of the economic stimulus announced, and increase the government’s revenues from indirect taxes in the long-run. Secondly, the formalisation of the informal sector would also help building an accurate database of the informal workers which eventually would help them to get access to various government welfare schemes over time. The Indian government during the present crisis had all the intention to reach out to every migrant labour, but the single largest problem that it faced was its inability to trace a large number of these migrant labours during the pandemic due to the absence of a comprehensive database.

Government’s role in handholding the transition of informal enterprises to the formal sector

It is highly probable that governments will put in efforts to expand the tax revenue post the pandemic which may target the informal sector. The Covid-19 scenario definitely will act as a catalyst which will push the informal sector towards formalisation of the database related to migrant workers in informal sectors to avail the benefits of liquidity in these times. However, the effects of this transition are far more complex than it seems on the surface. In countries like India, there are disincentives for businesses to become formalised, in terms of cost, time and risk. Corruption at many levels of government, weak rule of law, and unclear taxation rules, formality can feel both unnecessary and risky. For many business owners, formalising their enterprise means paying taxes demanded by obscure government offices (while seeing no reliable public benefits) or being asked to pay a bribe. For the government to convince informal firms to overcome this perception and register themselves will be a herculean task to begin with. Second, while the salutary effects are already visible, what may have missed one’s attention is that such formalisation could result in inadvertently shrinking the economy leading to slower growth. Third, we also have to take in account that more than 80 percent of India’s non-agricultural workforce is employed in the informal sector. The government should therefore be very careful while taking steps in the direction of formalising the informal sector. Forced formalisation may lead to large scale unemployment and affect the economy drastically. Considering these issues, the government ought to focus more on steps that would lead to a smooth transition of the informal sector to the formal economy. Handholding the informal sector while they make this transition should be on the government’s top agenda. Some steps that they could take with regards to facilitating this smooth transition are:

  • As the government compel the informal firms to register and become tax-compliant, it should also pay heed towards creating a proper safety net for the labourer’s working in these enterprises. The new labour codes seem to be steps taken in the right direction. The code on Social Security Bill, 2020 and the Occupational Safety, Health and Working Conditions Code Bill 2020 for example, will specifically expand the social security net for the informal labours and provide them with the much needed attention from the government.

  • The government should lay a long-term vision of increasing productivity of the informal sector by equipping them with technical and business skills, training, finance and enterprise support to compete in the markets.

  • Prioritise equity considerations in the post fiscal crisis responses keeping the economical and political vulnerability of the informal sector in mind.

  • Without effective identification, payments cannot be effectively targeted or delivered to the individuals or SMEs that need them  and it’s almost impossible to confirm that these payments have reached their intended target. The lack of formal ID has been one of the most crucial reason complicating the efforts to deliver economic relief to the small and medium enterprises. The government should therefore improve its mechanisms and make good use of the UIDAI and Pan Card, which would help expanding governments welfare schemes intended towards the SME’s registering to the formal sector.

However, having discussed the above points, it’s also worthwhile to mention the task at hand to formalise the informal sector is not an easy one, and more so during a pandemic. Previous experience of the government with the introduction of GST and demonetisation have not been very conducive with respect to its effect on the informal sector. Squeezing on the informal economy may well lead to large scale unemployment and result in demand contraction. Formalising could cause an initial distress in the informal economy and the situation could very well lead to the repetition of what happened during the demonetisation. The switch to formalisation will no doubt lead to a larger tax base for the government and enhance productivity but it will also extract cost from the most vulnerable of the informal firms and the workers.

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Rouhin Deb

Rouhin Deb

Rouhin Deb was an Associate Fellow at ORF Kolkata. His research focuses on informal competition strategic choices and international businesses.

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