Mains Practice Questions

Approach :

• Briefly define the India’s informal sector.
• Analyze the structural, financial, and regulatory challenges in formalizing India’s informal sector
• Suggest measures for preserving its employment generation potential.
• Conclude with a suitable way forward.

Introduction:

Informal employment broadly refers to workers who are employed in jobs where they do not have access to social security benefits under existing labour legislations.According to NITI Aayog (2021), nearly 90% of India’s workforce is employed in the informal sector, contributing almost 50% of GDP.Formalizing India’s large informal sector is vital for productivity, welfare, and revenue, but structural, financial, and regulatory hurdles make it risky for livelihoods if poorly executed.

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Structural Challenges

• Fragmented firm structure:
  • Predominantly micro and nano firms with low capital intensity and thin margins resist the fixed costs of compliance; many operate on subcontracting chains that complicate direct regulation.
  • Units are dispersed and poorly documented, making it hard to bring them into platforms like e-Shram, which has registered 29 crore workers but still excludes many.
• Heterogeneity of activities:
  • The informal sector spans street vending, construction, home-based manufacturing, domestic work and platform gigs — a single policy instrument cannot suit all.
• Low Productivity and Skill Gaps:
  • Informal workers often lack training, making transition into formal enterprises difficult.
  • As per Periodic Labour Force Survey (PLFS) 2022–23, over 60% of informal workers are engaged in low-skilled occupations.
• Digital Divide:
  • Reliance on digital portals for registration and compliance excludes those lacking access to smartphones or internet literacy.

Financial Challenges

• Credit Constraints:
  • Informal enterprises depend on moneylenders; formal banking penetration is shallow. Despite MUDRA Yojana (2015) disbursing over ₹19 lakh crore, many borrowers remain stuck in small-ticket loans.
• Cost of Compliance
  • Filing GST returns or maintaining digital accounts is costly for micro-entrepreneurs.
  • A 2020 World Bank report found that compliance costs often exceed potential benefits for micro units.
• Fear of Tax Burden
  • Many workers fear that formalization will increase taxation without proportionate benefits like pensions or healthcare.
• Social Security Funding
  • Extending EPFO or ESIC benefits strains both the exchequer and small firms, leading some to avoid registration.

Regulatory Challenges

• Multiplicity of Laws
  • Despite codification into four Labour Codes (2020), overlaps in state-level rules create confusion.
• Bureaucratic Hurdles
  • Lengthy registration and licensing discourage small units from entering the formal fold.
• Weak Enforcement
  • Informal workers remain outside legal protection due to poor monitoring.
  • The Unorganised Workers’ Social Security Act, 2008 has seen limited success.
• Worker Protection vs. Employer Viability
  • Rigid labour regulations may deter micro enterprises, leading them to remain informal to cut compliance costs.

Government Initiatives for Formalization of the Informal Sector in India

• Udyam Registration – formal identity for Micro, Small and Medium Enterprises (MSMEs).
• Goods and Services Tax (GST), 2017 – incentivizes registration via tax credits.
• Pradhan Mantri Rojgar Protsahan Yojana (PMRPY) – government pays Employees’ Provident Fund (EPF) share for new hires.
• e-Shram Portal – national database of unorganized workers.
• Pradhan Mantri Shram Yogi Maandhan (PM-SYM) – pension for informal workers.
• Pradhan Mantri Street Vendor’s Atmanirbhar Nidhi (PM SVANidhi) – loans to street vendors.
• Micro Units Development and Refinance Agency (MUDRA) Yojana – collateral-free loans.
• Labour Codes (2019–20) – consolidated, simplified regulatory framework.

Fomalization While Preserving Employment Potential

• Phased and Incentive-Based Formalization – Tax breaks, credit access, and simplified GST slabs for micro businesses.
• Skill Development – Tailored programs under PMKVY to upgrade informal workers’ skills.
• Digital Platforms with Outreach – Strengthening e-Shram with benefit portability across states.
• Cluster-Based Models – MSME clusters can reduce compliance costs. Example: Tirupur textile cluster adopted simplified norms and mechanization.
• Learning from Abroad – Brazil’s SIMPLES law simplified taxes for micro firms, boosting compliance without harming jobs.

Conclusion:

Formalizing India’s informal sector is not just a legal exercise but a socio-economic transformation.As Amartya Sen argued, development must enhance both freedom and security—formalization should therefore provide dignity and protection without eroding employment potential. A calibrated, inclusive, and incentive-driven approach remains the way forward.