India’s informal economy

Updated - December 04, 2021 11:27 pm IST

Published - September 03, 2014 01:10 pm IST

Discussions on the need for labour reform in India, recharged by recent decisions of the Rajasthan state government and the central cabinet, focus on the need to deal with the inflexibilities resulting from the application of the Factories Act. Too much of Indian manufacturing, it is argued, falls in the category of units subject to that Act, which employ 10 workers or more if functioning with the aid of power or 20 workers or more when functioning without the aid of power. This is seen as a reason to shift the definitional boundary, as is being done in Rajasthan to 20 workers with power and 40 without, so that more of Indian manufacturing is exempted from meeting the regulatory provisions of the Act, including those on the terms and conditions of employment.

However, evidence on the issue coming from reports based on the periodic employment and unemployment surveys (EUS) conducted by the National Sample Survey Organisation suggests that only a small share of employment is in the organised sector so defined. The most recent is the just released report on the “Informal Sector and Conditions of Employment in India” based on the employment and unemployment survey conducted in the 68th round of the NSS during July 2011 to June 2012.

The NSS adopts a definition of the “informal sector” which, in the case of manufacturing, is very different from the residual sector excluded from the statutory definition of the organised manufacturing sector. The report identifies the informal sector as consisting of proprietary and partnership enterprises (excluding those run by non-corporate entities such as cooperatives, trusts and non-profit institutions), in the non-agricultural sector and in agriculture-related activities excluding crop production (AGEGC).

These kinds of non-agricultural enterprises are the ones that do not correspond to the organisationally more modern enterprises that economists like Simon Kuznets saw as coming to dominate the non-agricultural sector in the course of development. In that view, besides the diversification of economic activity away from agriculture, modern economic growth would be accompanied by an increase in the size of non-agricultural enterprises and a growing role for impersonal forms of organisation (such as the joint-stock company).

Using this definition of the informal sector, the EUS for 2011-12 estimated employment in the informal component to be about 75 per cent of total usual status employment (principal and subsidiary) in the rural areas and 69 per cent in urban areas. The non-agriculture and AGEGC sectors themselves accounted for 41 per cent and 95 per cent of total employment. The figures for informal employment are likely to be even larger because enterprises identified as “employer’s households”, which account for employment like the provision of domestic services, are excluded from the definition of the informal sector.

This implies that an overwhelming share of non-agricultural employment is in the “informal sector”. The sub-sectors that account for a dominant share of informal sector employment are manufacturing, construction and trade (wholesale and retail). They accounted for 76 per cent and 68 per cent respectively of all workers in the non-agriculture informal sector, in the rural and urban areas, as compared with 71 per cent and 56 per cent respectively of all workers in the non-agriculture sector.

The fact that sectors like trade and construction are important contributors to the unorganised sector and to informal employment is of significance, given the argument that it is regulation that is responsible the proliferation of unorganised units and informal employment. The really stringent form of size-based regulation applies to the manufacturing sector, in which units that meet the criteria set by the Factories Act, 1948 need to register themselves and be subject to factory legislation. This legal distinction does not apply to non-agricultural sectors outside manufacturing.

This fact notwithstanding, it would be useful to assess the size of the unorganized sector, if the same criteria used to define unorganised manufacturing are applied to other non-agricultural sectors as well. This can be done using information culled from unit level data relating to the employment and unemployment surveys for 2004-05, 2009-10 and 2011-12. This period more or less covers the years of high growth, when GDP was increasing at a compound rate of 8-9 per cent per annum in most of the years. This should have had some impact on the nature of employment with an increase in the share of ‘organised sector’ employment.

Between 2004-05 and 2011-12, total employment in the country rose from 457.9 million to 472.4 million. Over the same period employment in the organised, non-agricultural sector, defined to include all units with 10 or more workers if using power and 20 or more workers if not using power, rose from 28.8 million to 47.7 million, whereas employment in the unorganised sector rose from 185.4 million to 209.6 million. That is organised sector employment stood at 6.3 per cent and 10.1 per cent respectively of total employment in 2004-05 and 2011-12. In absolute terms there were more who joined the unorganised sector’s workforce than the number who entered the organised sector between the two years. Even in 2011-12, as much as 86 per cent of workers in the private sector and 50 per cent in the public sector were in units that could be designated as unorganised based on employment size.

What would happen if the definition of the organised sector is changed to include all units that employ 20 workers or more , whether they use power or not? That is the definition closest to that suggested as part of the recent labour reform in Rajasthan. According to the NSS, that would take the share of workers employed in the unorganised sector in 2011-12 to 83 per cent in the public sector and 92 per cent in the private sector, or to 91 per cent of total non-agricultural employment as compared with 81 per cent as per the current definition.

Needless to say, relying on employment size of units alone would exaggerate the size of unorganised employment relative to a measure of informal employment based on nature of the employment contract. While the implementation of labour reform uses the employment size definition to demarcate the universe to which regulation must apply, the substance of reform relates to the nature of employment. The evidence from the 2011-12 NSS survey regarding the nature of employment outside of crop production is striking. According to the survey, among the employees in the AGEGC and non-agricultural sectors, about 79 per cent had no written job contract - the proportion was about 85 per cent in rural areas (86 per cent for males and 81 per cent for females) and about 73 per cent in the urban areas (73 per cent for males and 72 per cent for females). What is more, “the proportion of employees without written job contract has increased between 2004-05 and 2011-12 for males and females of both rural and urban areas. In the AGEGC and non-agriculture sector, the proportion of employees without written job contract increased from 74 per cent in 2004-05 to 79 per cent in 2011-12. During this period, this proportion increased from 79 per cent to 86 per cent for rural males, from 78 per cent to 81 per cent for rural females, from 68 per cent to 73 per cent for urban males and from 69 per cent to 72 per cent for urban females.’

In fact, a useful exercise is to rely on the unit level data from NSS surveys and consider the proportion of employment where any one of three features— written contract, provision of social security (pension etc) and eligibility for paid leave—is present as indicative of employment being ‘formal’. Let us also separate out the organized and unorganized sectors in terms of the employment-size based definition referred to above. The results are striking. It emerges that 25.6 per cent of employment in the “unorganized” public sector and 23 per cent of employment in the organized public sector is “informal”, whereas 94.5 per cent of unorganized and 54.3 per cent of organized employment in the private sector is informal in nature. (If we make the criterion more strict, and designate employment as formal only if some social security benefit is provided, then the figures change to 41.7, 32.2, 98 and 67.2 respectively.) Thus, when approached from the employment side non-formal employment still constitutes an overwhelmingly large proportion of employment outside of crop production in India. This questions the grounds on which the need for labour reform is often defended.

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