What policy makers need to do to make the informal sector vibrant

Ranjula Bali Swain, Arup Mitra*
Many components within the informal sector share close linkages with the formal sector. In such a situation if the formal sector is growing rapidly it is natural that the informal sector would benefit from the percolation effects. However, in reality the informal sector is characterized in terms of low productivity and meagre earnings, explaining considerable overlaps with poverty and slum-dwelling in cities.
Agglomeration economies work and they contribute to productivity growth as a result of which the real wages in the cities tend to be higher compared to the rural areas. Yet, urban poverty exists which warrant an explanation. Some of the reasons of course can be envisaged in terms of a high degree of heterogeneity this sector possesses. There are residual activities with almost no entry barriers and they often involve excess supplies of labour relative to demand. Similarly, there are self-employed households both in manufacturing and services, operating with inadequate resources, low level of technology, poor market information and with almost no product or process innovation. Envisaging upward mobility in such segments is rather difficult.
Information asymmetry pertaining to the urban labour market is also a cause of poverty among many. The informal networks through which the urban job market information is accessed, are often seen as the cause of mismatches between labour demand and supply. Labour market segmentation and the lack of upward mobility occur because of the perusal of similar networks or the absence of network diversification.
Why the components which share a close tie with the formal sector firms still lack progress? The business outsourcing activities are carried out through intermediaries who deny a variety of benefits to the informal sector workers. With a contract to supply to the formal sector firms one would expect the informal sector enterprises to have the income security. Though in reality the fluctuations in consignments have not been substantial, prospects for improved wages have been ruled out by the intermediaries. Neither in terms of employment nor productivity and wages the units with a linkage with the formal sector are better-off in comparison to those who function independently. Similarly, the labour contractors who facilitate the informal employment in the formal sector stand out as the sole culprits.
After the recent pandemic and the lockdown hit the urban sector drastically the informal sector workers obviously suffered the most. Now, in the context of reviving the economy the urban informal sector must receive a great deal of planning and intervention. Given the heterogeneity, the recommendation of a uniform set of policy does not appear meaningful. However, a couple of strategies sound logical. The role of the intermediaries will have to be regulated; else, in the name of flexibility the informal sector workers will remain deprived of the minimum benefits.
There are irregularities and harassments regarding space on which the informal sector functions. Reservation of space will have to be provisioned as a public good and the rent seeking behaviour of the local government employees will have to be controlled. Product innovation and process innovation will have to be encouraged with greater disbursement of loans and dissemination of information about the market. Workers who experienced time independent mobility in the past unfold their success in generating savings and converting them into investible resources. Such willingness to pursue productive investment will have to be nurtured significantly for better outcomes to emerge.
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*Professor Ranjula Bali Swain is Research Director, Center for Sustainable Research (CSR), Stockholm School of Economics & Professor of Economics, Södertörn University, Sweden; Arup Mitra is Professor, Institute of Economic Growth, Delhi