PROBLEMS OF INFORMAL SECTORS IN

URBAN AREAS

Presented by:-

SUVADIP BHOWMIK
Ph: +919571632903

E-mail: [email protected]

Informal Sector – A Brief Background:

• In the 50s and 60s, the informal sector was not explicitly taken into consideration by most
governments of developing countries while devising their policies. This lead to manifold
discrimination of those belonging to the informal sector. A result of these practices of
discrimination which to some extent prevail until today, the chances of those active in the
informal sector of achieving an income in this sector which is sufficient to cover their and
their families physical and cultural minimum of existence are very low. Besides this policy-
related discrimination by the government and public administration, those belonging to the
informal sector are also subject to economic discrimination: Due to a lack in material
securities, they have no access to the formal market for credits. Therefore, they are almost
unable to attain factors of production that are complimentary to their labour on acceptable
terms. In many cases, these discriminations prevent those affected from improving their
situation on their own: The constellation resembles that of a vicious circle that can only be
broken with external assistance.

• Initially, labour statisticians considered “informal sector” as composed of urban “working

poor” migrated from rural areas in search of work. Later, recognised as an important
employment, production and income generating sector – presently as much as in rural areas as
in urban areas. The official statisticians have referred to this segment – or a closely
comparable one – by various names like “unregistered”, “unorganised” and “unrecorded”
segment of the economy.

• The SNA (System of National Accounts) 1993 identified “informal sector” as one of the
segments of economy that are not covered or not adequately covered in the national accounts.

• The three main criteria of defining the informal sector, as adopted by the 15th
ICLS(International Conference of Labour Statisticians), refer to:
 Absence of legal organisation (unincorporated enterprises)
 Type of accounts (no complete set of accounts)
 Product destination (at least some market output)

• In 1994, the National Statistical Office (NSO) of Thailand carried out a national survey of the
informal sector in all economic spheres, including agriculture, manufacturing, trade and
service. Definitions used by NSO were:
(a) The formal sector: Organizations that have defined
management and administrative systems, including government and private
agencies that employ at least 10 persons;
(b) The informal sector: Enterprises typically operating on a small scale with a low
level of organization, low and uncertain wages, and no social welfare and security.

• ‘The informal sector is unorganized, unregulated and mostly legal, but unregistered’.
-According to European Journal of Economics, Finance And Administrative Sciences - Issue
11 (2008).

• In India, the term informal sector has not been used in the official statistics or in the National
Accounts Statistics (NAS). The terms used in the Indian NAS are ‘organized’ and
‘unorganized’ sectors. The organized sector comprises enterprises for which the statistics are
available from the budget documents or reports etc. On the other hand the unorganized sector
refers to those enterprises whose activities or collection of data is not regulated under any
 legal provision or do not maintain any regular accounts. In the unorganized sector, in addition
to the unincorporated proprieties or partnership enterprises or partnership enterprises,
enterprises run by cooperative societies, trust, private and limited companies are also covered.
The informal sector can therefore, be considered as a sub-set of the unorganized sector.
Thus unorganized sector has a crucial role in our economy in terms of employment
and its contribution to the National Domestic Product, savings and capital formation. At
present Indian Economy is passing through a process of economic reforms and liberalization.
During the process, merger, integration of various firms within the industry and up gradation
of technology and other innovative measures take place to enhance competitiveness of the
output both in terms of cost and qualitative to compete in the international market. It has been
experienced that formal sector could not provide adequate opportunities to accommodate the
workforce in the country and informal sector has been providing employment for their
subsistence and survival.

• There is a widespread consideration that the economic activities taking part outside the formal
economy has a substantial and increasing amount. This view is valid not only for the
developing countries but also for the developed ones. This is why the issues related with the
informal economy attracted the interests of the academicians, policy makers and others.

• The presence of informal economy is not an individual reason demolishing the proper
functioning of an economy; rather it is a consequence of other financial, political, social and
economic factors. At the same time, this “consequence” cause - especially in developing
countries- a number of economic problems which must be overcame immediately.

• In general, “informality is a common term for the output and workforce of firms not registered
with the government as well as the unreported activities and workforce of registered firms.”

Informal Sector-Definitions:

The First Indian National Commission on Labour (1966-69) defined ‘unorganized sector
workforce’ as –
“those workers who have not been able to organize themselves in pursuit of their common
interest dues to certain constraints like casual nature of employment, ignorance and
illiteracy, small and scattered size of establishments”.

The urban informal sector, often called the urban subsistence sector/unorganized sector is
conceptually defined to include all economic activities which are not officially regulated and
which operates outside the incentive system offered by the state and its institutions. In contrast,
enterprises which enjoy official recognition, protection and support are defined as formal sector
enterprises.

At the empirical level, the informal sector often is defined to comprise these economic
enterprises which employ less than certain number of persons (e.g. 5 or 10, depending on the
country's official procedures) per unit, and which simultaneously satisfy one or more of the
following criteria:
 (a) It operates in open spaces,
(b) It is housed in a temporary or semi permanent structure,
(c) It does not operate from spaces assigned by the government,
municipality or private organizers of officially recognized market-places,
(d) It operates from residences or backyards, and
(e) It is not registered.

The three facets of the informal sector are:

PEOPLE Labour force: analysis is mode from labour market perspective (job search
model, labour segmentation etc.)

ACTIVIT Economic enterprise/business/firms: analysis is mode from the industrial

Y organization perspective (market structure, market conduct, and market
performance)
HABITAT Information settlements (squatters and slums): culture of poverty thesis and
similar sociological aspects used to dominate analysis; current trend is to use
housing problems

Segments of Informal Economy:

 Agriculture: landless labourers, small farmers, traditional artisans, animal husbandry

 Industry: workers in brick-kilns, construction, beedi-making, incense stick

 Services: workers in local transport, shops, domestic servants, community services like
street cleaning, street vendors, garbage collectors

 Small Workshops: shoe makers, garment makers and embroiderers

 At Home: garment workers artisans or craft producers

 On Rivers, Ponds, Lakes, and Oceans: fishermen, shippers

Characteristics of the informal sector land and housing:

1. Unauthorized use of vacant public or private land

2. Illegal subdivision and/or rental of land
3. Unauthorized construction of structures and buildings
4. Reliance on low cost and locally available scrap construction materials
5. Absence of restrictive standards and regulations
6. Reliance on family labour and artisanal techniques for construction
7. Non-availability of mortgage or any other subsidized finance

Characteristics of informal credit markets:

 1. Unregulated and non-subsidized
2. Easy accessibility
3. Availability in very small size and for short terms
4. Low administrative and procedural costs
5. Little of no collateral requirements
6. Flexible interest rates (from very high to no interest at all)
7. Highly flexible transactions and repayments tailored to individual needs

Critical characteristics:

1. Socio-economic conditions including illiteracy and level of awareness in critical areas

2. Nature of work (seasonal, entails migration in search of jobs)
3. Payment:
 Low/irregular wages or income
 Delayed/no payment of wages
 Generally piece rate basis or on daily basis
4. Social security (formal/govt. and informal/family/lender)
5. Formally organized as a union/association
6. Bargaining power (formal through association and informal through
expertise/caste/education level)
7. Working conditions – health and safety
8. Harassment by police, govt. officials
9. Nature of child care and family support at home
10. Nature and intensity of problems in obtaining alternative employment
11. Provision/non provision of reasonable capital/credit.

Informal Sector in urban areas refers to economic activities i.e., production and distribution of
goods and services by the operating units of the households which essentially differ from the
formal sector in terms of technology, economies of scale, use of labour intensive processes, and
virtual absence of well maintained accounts. It is informal in the sense that they are not regulated
by government under any statute. Because of its contribution to the economy, which is quite
visible and its strength in absorbing a huge chunk of unemployed persons to whom the State is
unable to provide adequate employment, it becomes the duty of the policy makers to device such
policies which can take care of the problems faced by the informal sector workforce.

There is no agreement on how to define the informal economy, or even what to call it.
“Underground,” “shadow,” “black,” “unofficial,” “unrecorded,” “hidden,” “parallel,”
“clandestine” and “second” economy are all used by researchers to describe roughly the same
phenomenon. The informal economy as all activity which often escapes official economic
statistics, such as Gross Domestic Product (GDP), through accounting conventions, non-reporting
or underreporting.

Non-registration of an enterprise is one of the factors used to determine if an enterprise or

establishment is part of the informal sector. It is often assumed that small firms usually are not
well organized and have limited access to technology and therefore, should be classified under the
informal sector. However, this assumption is not accurate for all enterprises, such as those that
specialize in outsourcing information technology. The informal sector is just as component of the
 non-observed economy which also consists of illegal and/or underground/concealed activities; or
household production for own final use.

The rather short-term character of many informal arrangements lends itself to a latent instability
of economic (and social) relationships, which, for example, is demonstrated by the fact that many
of them often change jobs. The necessity to become familiar with continually new processes of
work makes it difficult for a routine for certain tasks to develop. Hence, dynamic effects of scale
can only be utilized to a limited extent. In the case of the comparatively low degree of
specialization observed in the informal sector, the tasks that are repeated for a specific period of
time possibly remain below a critical level that is necessary for the realization of such effects.
Thus, productivity when compared with a method of production that places greater emphasis on
the division of labour suffers. With the existence of such a decline in productivity, one could also
explain, why the incomes in areas of informal modes of production stay clearly below those of the
formal sector. Thus the question arises, through which concrete measures of development
cooperation these differences in income and the associated absolute poverty, which is particularly
wide-spread in the informal sector, can be reduced.

Briefly it can be stated the causes and motives of the informal sector in an economy as
follows:
- Economic system and the structural features of the economy,
- Inequalities in the income distribution,
- Rapidly increasing population and immigration from rural areas to the cities,
- The structure of the economic preferences and economic policies,
- The problems that are caused by the public sector economics (i.e. tax
system),
- The intensity of the government regulations,
- Lacking of public sector services because of the inadequate tax revenues
caused by the existing informal sector (this causes the formal economic
agents to go informal),
- Changing production patterns: Particularly from the very beginning of
1980’s, the intensity of competition increased because of the enlargement
of markets and diversification of demand patterns, and this resulted in a
flexible and information based production system which boosted the
informal activities,
- Tax exemptions and exceptions especially in the developing countries,
- High level of inflation,
- Economic crises and stagnation,
- Tax resistance and the citizens’ perception about the fairness of public
expenditures,
- Inequalities in the distribution of tax burden,
- Frequent tax amnesty and additional taxes,
- High levels of tax ratios,
- Political instability,
- Failure of tax laws to comply with the economic, social and financial conditions of the country,
- Incomprehensible tax laws,
- Problems in the taxation of e-commerce and international transactions,
- Intensity of national and international competition.
Concept of Informal Sector:

The informal sector plays an important and controversial role. It provides jobs and reduces
unemployment and underemployment, but in many cases the jobs are low-paid and the job
security is poor. It bolsters entrepreneurial activity, but at the detriment of state regulations
compliance, particularly regarding tax and labor regulations. It helps alleviate poverty, but in
many cases informal sector jobs are low-paid and the job security is poor. The size of the informal
labor market varies from the estimated 4-6% in the high-income countries to over 50% in the low-
income countries. Its size and role in the economy increases during economic downturns and
periods of economic adjustment and transition.

The informal sector covers a wide range of labor market activities that combine two groups of
different nature. On the one hand, the informal sector is formed by the coping behavior of
individuals and families in economic environment where earning opportunities are scarce. On the
other hand, the informal sector is a product of rational behavior of entrepreneurs that desire to
escape state regulations. 

The following flow chart attempts to define the characteristics of enterprises in urban areas,
particularly micro-enterprises that can be called "informal". The flowchart also focuses on the
unique features of informal sector enterprises (or 'what it really is'), rather than simply
comparing/contrasting it to the characteristics of formal sector enterprises (or 'what it is not').

The flowchart positions a number of criteria that characterizes informal sector enterprises. These
include, for example, number of employees or place of operation or registered enterprise.

Ultimately, if an enterprise employees less than 10 persons, satisfies any one of five criteria
(unregistered, operates in an open space, housed in a temporary structure, not officially
recognized, operates from a residence), and is not officially regulated or supported, then the
enterprise can be called an informal sector enterprise.

The flow chart helps in better understanding the conditions within which an informal enterprise
functions, and points to the areas where policy should focus on, rather than simply trying to
'eliminate' them since it is not 'formal'. For example, the criteria, "housed in a temporary
structure" implies that it is necessary for us to focus positively and proactively on policies that
provide good and environmentally safe working spaces, and not just on enforcing rules and
standards that do not fit the situation of informal sector enterprises.
Flowchart for Identifying Informal Sector Enterprises
 The informal sector does not stand isolated next to the formal sector. In fact, it is closely
connected to it in various ways through markets for goods and factors. For example, numerous
formal companies in developing countries are being supplied with cheap intermediary goods from
the informal sector. Also the fact that many subjects of economic activity carry out a formal
occupation (e.g. formal employer-employee relationship) as well as informal activities (e.g.
manual (odd) jobs, cultivation and marketing of agricultural goods) documents the connection
between the formal and informal economy as well as the redundancies that are inherent in a
classification of informality which is based on subjects of economic activity rather than economic
relationships.

Problems and Challenges of Informal Sector in urban areas:

• As stated above, informal labour is an unprotected labour. Poverty and underemployment

have compelled them to work in whatever terms and condition. The size of the informal sector
is a direct measure of the failure of socio-economic policies.
• Illiteracy and the ignorance is another big problem in this sector. There is a 'contrasting
relationship' between our society dominated by the social conservatism and the unaware
informal sector's labour force. This is a hindrance in our progress.
• The numbers of employer has registered no where in informal sector and the employees
perform their job just in an informal understanding, it does not follow any legal formality.
Due to lack of legal proof during the time of labour disputes, workers are often sidelined and
kicked out of the job in an inhumane manner. Also, 'job security' is an unimaginable notion to
them. On the one hand, employers always escape safely by using legal loop-holes, and on the
other, because of weak legal basis workers themselves do not expect any legal treatment.
• Labour migration to urban areas of heavy influx of rural migrant labour is another big
problem of formal sector.
• Given the disadvantaged position of women in the labor market in most parts of the
developing world -- the result of long-standing societal norms which discourage the social and
economic integration and advancement of women -- the majority of female workers are in the
informal sector.
• Moreover following factors are very prominent in the informal sectors:
 Difficulty in accessing finances due to restrictive legislation. Alternative lending carry
high interest rates.
 Almost non-existent training and extension facilities related to technology transfer and
micro enterprise management accounting skills.
 Inadequate information on business opportunities, available services, new technologies
and support programs.
 Poor physical infrastructure facilities
 Lack of safe nets incase of job loss, injury, sickness and death.
 Globalization removed trade barriers and therefore opened the sector to competition with
cheap high quality/subsidized products from developed countries.
 Absence of organized and recognized interest groups e.g. unions, associations to deal with
government and solve the problems affecting the sector.
 Inadequate regulatory policies, and regulations to address unique informal sector
problems.
  Lack of accurate and reliable data, on skills inventory, business opportunities employment
opportunities and available goods and services within the urban informal sector.
 Discriminatory attitude by private sector, donors, and formal sector services/products from
informal sector are only made for the poor.

Conclusion:

Informal sector is not an isolated sector; it has interdependence with the formal sector. That's
why, it is not only surviving, but also increasing day by day.

There are number of models of providing social security to the workers in the unorganised sector.
These may be classified as under:
 Centrally funded social assistance programmes.
 Social insurance scheme.
 Social assistance through welfare funds of Central and State Governments,
 Public initiatives.
But our policies should be more transparent towards the development of these unorganized
sectors.

The informal economy can however no longer be considered as a temporary phenomenon.

Furthermore, the informal economy has been observed to have more of a fixed character in
countries where incomes and assets are not equitably distributed. It seems that if economic growth
is not accompanied by improvements in employment levels and income distribution, the informal
economy does not shrink. The situation is therefore that the informal economy is continuously
increasing in most developing countries, even in urban areas.

A modern economy can be made up of sectors and activities with very different sizes, types of
technology, styles of organization and degrees of integration into local, national, regional and
international markets. The fundamental purpose of any economic system is the well-being of the
individuals, their families and communities. Economic power, the growth of national income, the
increase of profit, the enlargement of a firm are only instruments. Deified, they become obstacles
to the welfare of the population. To modernize the economy is to use the best techniques available
to allow the individual to work, to create, to earn an income, and to enforce the rights of
employees and workers.

Finally, it can be concluded that, the informal sector is of great importance in both rural and urban
areas. Even the metropolitan cities have a large informal commercial sector. Nevertheless, the
informal sector plays a complementary rather than competing role in relation to the formal
commercial sector. While the informal sector cannot be included within the framework of central
place functions, still it cannot be ignored altogether.
References:

‘Sample design considerations for informal sector surveys’ by Vijay VERMA, Research Professor, University of Essex
Colchester CO4 3SQ, U.K. ([email protected])

FEDERAL MINISTRY OF FINANCE AND ECONOMIC DEVELOPMENT: Multi-Sartorial Needs Assessment for
Technical Corporation March, 1992.

Amitabh Kundu, (1993) - “Urban Informal Sector: An Overview of Macro Dimensions, Socio-economic Correlates and
Policy Perspectives in India”, in H. Nagamine (ed) ‘Urban Informal sector Employment - A cross National Comparative
Study’, Research Institute for Regional Planning and Development, Nagoya.

B. K. Pradhan, P. K. Roy, and M. R. Saluja (1999), “Informal Sector in India: A Study of Household Saving Behaviour”,
Cont ribution of the Informal Sector to the Economy, Report No. 1. New Delhi: National Council of Applied Economic
Research.

Maloney, William F. (2001), “Informality Revisited”, Mimeo, World Bank.

D. Mazumdar, (1976), “The Urban Informal Sector”, World Development, v4, n8, pp. 655-79.

G. Gereffi and L. Cheng (1993), “The Role of Informality in East Asian Development with Implications for Mexico”, in:
Work Without Protections: Case Studies of the Informal Sector in Developing Countries, US Department of Labor.