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Mainstream, Vol XLVII, No 25, June 6, 2009

Labour Absorption: A Unique Strength of the Informal Sector in India

Saturday 6 June 2009, by Vinod K Anand


The end objective of a nation, notwithstanding its economic, political, and social scenarios and the accompanying constraints, is the “well-being” of its people. The multi-faceted connotation of “well-being” is captured by what is termed in Economics as development with its focus both on growth and distribution, and also their interlinks. The important issue is whether the link runs from growth to distribution or the other way round. Since the 1950s much of the focus has been on the link running from growth to distribution. During that era countries depended solely on the growth process to attain the objectives of employment-creation and social justice in terms of desirable income distribution. The generally accepted hypothesis was that inequality in income distribution would rise in the initial stages of development and then fall. But this was not supported by the experience of the Third World counties and the generally accepted hypothesis of the fifties lost its force, and the new literature has turned the earlier thesis on its head and focuses on how the social objectives of employment, income distribution, and poverty alleviation influence growth through their effect on a number of variables like political stability and fiscal policy. (Anand, 1999) Extreme unemployment, poverty, and income inequality adversely affect growth not only via social unrest and political instability, but also through other means. The higher the intensity of these variables, the greater the incentive to engage in illegal and illegitimate activities. This poses a threat to property rights. Markets will not work well, and investment will be poor, which will eventually result in low growth.

Looking at the economic history of nations, and also their public policy in perspective, it becomes very clear that the central concern, in smaller or greater degree, has always been not in the goods produced, but in providing employment for all who seek to produce them. The goods are not missed, but the employment is sorely wanted. This concern has become more serious in recent times. We quite often raise a question: why is it impossible in the modern economy to find useful employment for so many people who are willing to work? (Galbraith, 1987) It is not easy to categorically answer this because, along with this and other similar questions relating to public policy, there goes a consideration of the institutions that are involved in economic activity in the production and pricing of goods and services and the distribution of the proceeds. In this context the role of the business enterprises of all sizes also becomes important, and so are the banks and other financial institutions, and also international trade and commerce. In this kind of a backdrop, this paper briefly looks at the distribution and equity scenario as it has existed in India in recent decades, and then it focuses on the objective of employment generation, and justifies it as a policy priority for the country both during the pre-reform and the post-reform periods. It also dwells on the small-scale segment of the informal sector as a way out to generate sufficient employment opportunities for the rising labour force.

THE problems of employment-creation, income-distribution and poverty-alleviation are common to most low and middle-income countries. India is no exception. Despite a paradigm shift in the whole macro-economic management in 1990-91, the social indicators of absolute poverty line, the Gini-Lorenz ratio, and unemployment rates present a mixed scenario. Whereas the number of people below the poverty line declined from a massive 54.9 per cent in 1973-74 to a low of 36 per cent in 1993-94, and inequalities in the distribution of consumption expenditure (in terms of the Gini-Lorenz ratio) have declined over time to little less than 0.30, the improvement in the unemployment situation is not very encouraging. The incidence of unemployment, which was 1.90 per cent of the labour force in 1993-94, went up to 2.23 per cent during 1999-2000. Over and above all this, according to the available data (Economic Survey, 2001-2002), the incidence of poverty in the country, expressed as a per centage of people living below the poverty line, was 26.10 per cent in 1999-2000. Although it has witnessed a steady decline, the number of poor people remained stable at around 320 million for a fairly long period of two decades, the eighties and the nineties, due to a countervailing growth in population, and beyond that the poor are still subject to periodic malnutrition during periods of man-made and natural disasters. Although poverty has declined at the macro level, the rural-urban and inter-State disparities are still visible.

Attempts to deal with poverty are hampered significantly by the limited availability of formal sector employment. The combination of a rapidly growing labour force with declining employment opportunities in the country is compounding significantly the employment, income distribution and poverty alleviation issues. As a result, employment creation continues to be a policy priority.

An additional factor is the limited, out-of-reach, expensive, and competitive educational opportunities for formal schooling available within the country, especially in remote rural areas. As a result, the labour force has a disproportionate number of relatively unskilled labourers. Therefore, the immediate challenge is providing employment for low-skill labour, given a distinct managerial constraint. The government seeks to reduce its role as the primary employer, which is the basis for its interest in assessing whether non-formal micro-enterprises can serve as primary source of employment creation.
India has now entered the second phase of reforms. The economic impact has been encouraging (though slowly) especially on the industrial front through various policies including the policy of

• complete delicensing leading to lesser hassles for the industrialists;

• ease of entry of foreign investors, leading to more foreign direct investment, especially in consumer goods and durables; and

• trade liberalisation, leading, amongst other things, to liberal imports in the country, and also to export competitiveness.

Coupled with all these is the development of the information technology sector which is, perhaps, more because of the technological boom in the United States, and India’s subsidised system of higher education in that sphere, and less because of economic reforms. Despite these shifts, it is rather unfortunate that the country is experiencing the lowest industrial growth and low-profit growth, because of an acute slowdown in the manufacturing sector. This has led to the process of restructuring and downsizing, and, hence, to the reduction in the existing employment opportunities because of the recently introduced voluntary retirement schemes (VRS) and retirement policies. All this has resulted in a severe lack of job security, and has further added to the gloomy employment scenario in the country.

THE economic impact on the agricultural front has not been satisfactory too. In fact, there has been a prolonged stagnation in agriculture in recent years, which has led to a slack of demand for industrial goods. There is, therefore, an urgent need of egalitarian economic reforms, and effective food security system. The social impact of the reforms process has almost been negligible in terms of poverty alleviation, employment creation, and income equalities, basically because of poor governance and ineffective implementation of laws. In fact, it appears that the social sector reforms have not yet begun.

In this kind of a gloomy backdrop, the government had unveiled a 14-point reform agenda in the September of 2001 to reverse the economic slowdown. This agenda had focused on the following:

• both the Centre and States would have to take hard and unpopular decisions to achieve a growth rate of eight per cent in the Tenth Plan (2002-2007);

• the Centre would focus on downsizing, power, labour, financial reforms, agricultural, industrial, and services sectors;

• the Tenth Plan would have a strong pro-poor focus;

• executive accountability would be re-oriented towards results by stressing on implementation and making the Tenth Plan a people’s plan;

• the quick solution to the country’s economic problems would entail difficult decisions, both by the Centre and the States;

• unproductive and unnecessary expenditure would have to be pruned;

• living on borrowed money and borrowed capital would never be a mark of good governance.

As is usual in our political set-up, this agenda is nothing else except the rhetoric of the political entrepreneurs, and has so far not taken us anywhere, and there is no hope that it will help the country in any way in the future also.

Employment generation has been a policy priority in India ever since the time of independence, and the focus has been mainly on the small-scale and cottage industries. It is interesting to have a brief overview of the government’s efforts in this context. A Cottage Industries Board was established in 1947 which was later split up into three boards: the All India Handloom Board, All India Handicrafts Board, and All India Khadi and Village Industries Board. This was not all. Three more boards were also set up. These were the Small-Scale Industries Board, Coir Board, and Central Silk Board. This was not the end of the story. Four Regional Small Industries Service Institutes with a wide network were also established for providing technical support to the entrepreneurs. The concept of Industrial Estates also came into being in 1955, and many Industrial Estates were also established. The Industrial Policy Statement of December 1977 introduced the concept of District Industries Centres (DICs), which was finally implemented in 1979. There was another interesting move, which related to the nucleus industry programme according to which a nucleus of micro and small units were to be encouraged around a core unit in different areas. The government has been initiating many other steps from time to time to promote the development of small-scale and cottage industries in the country. In the crucial year of 1991, a policy package for tiny, small, and village industries was also announced to give further encouragement and support to this sector. The Ninth Plan (1997-2002) also immensely focused on the small-scale sector, which was provided with necessary incentives and support to meet the emerging competition from large industry, including multinationals. It is expected that even the Tenth Plan (2002-2007) will recognize the importance of the small-scale sector, and will have an effective package for its survival and support in the second phase of the Reforms process.

It is now clear that the government has always tried to promote and support the small-scale sector in various ways. But the fact remains that

• the sector is still inhibited by a number of constraints “including technological obsolescence, inadequate and irregular supply of raw materials, lack of organised market channels, imperfect knowledge of market conditions, unorganised nature of operations, inadequate availability of credit, constraint of infrastructure facilities including power etc. and deficient managerial and technical skill”;

• the closure rate of micro and small firms has been high;

• there has been flaws in the implementation programmes in terms of the lack of effective co-ordination among the various support agencies;

• the benefits of the various schemes introduced from time to time (Anand, 1999; Anand, 2001A) do not reach the grass root beneficiaries because of many reasons, including the failure of the trickle-down effect (Anand, 2001B);

• all these constraints have resulted in a skewed cost structure placing the small-scale units at a disadvantage as against the large industries, both in the domestic and export markets.

WE have so far looked at employment generation as a policy priority from the point of view of micro and small units that constitute an important segment of industrial structure/organisation. These units can also be looked at as constituting an important component of labour market. The literature (Grootaert, 1992; Mazumdar, 1989; Thomas, 1992), which looks at these units from a labour market perspective, distinguishes between protected and unprotected designation to define informal activities. As has been mentioned by Rempel, Anand and others (1994), “protection for formal activity employees is provided by closed-shop labour unions, legislated minimum wages, various labour laws, government as wage leader, a hierarchy of defined forms of advancement within large firms, and wage-efficiency relationships. Within this designation, non-formal activities are not protected via such means. The majority is self-employed who, by definition, will not be protected by a labour union. As governments at all levels do not formally recognise non-formal activities, the self-employed and the employed are not subject to government labour legislation, they do not receive government services nor are they protected by labour, safety, health, and minimum wage legislation.” We, thus, have two perspectives of informal activities: the perspective of industrial organisation, and that of labour market. An attempt has also been made (Kavuluvulu, 1990) to combine these two perspectives. In that case the informal activities get bound by some kind of government regulations essentially concerning the labour laws. The labour market issues of the informal sector, and also the combination of the two perspectives becomes important especially in the context of structural adjustment. There are two reasons for this (Vandemoortele, 1991):

• the response of the economic system to the policy changes and incentives is determined, amongst other things, by the structure and behaviour of the labour market via labour mobility, wage flexibility, productivity gains, etc.;

• the impact of these policy changes on the labour market will determine if the adjustment process will be (i) socially sustainable from the point of view of employment and labour incomes, and (ii) if it will be politically sustainable in terms of political stability.

The social impact of the adjustment process in the context of employment and its related variables is thus of crucial importance. There is no denying the fact that any indifference in this regard will surely upset the reforms process.

In this kind of a set-up, therefore, employment generation, essentially by the small-scale sector, is not only a policy priority, but also the only way out to give a push to the economy, and for this all the obstacles inhibiting the existence and expansion of micro and small firms have, somehow, to be eliminated. An effective and efficient absorption of labour in the overall employment stream is a unique strength of the informal sector, essentially its micro and small segment. We must, therefore, provide all support to this sector so that the employment scenario in the country becomes brighter. We also have to move forward to reform our labour laws if we want to be taken seriously by the developed world, especially at the WTO forums. This is a Herculean task, and the end result is perhaps subject to many inbuilt political, social, and other assumptions.


For detailed discussion on these issues see Galbraith (1987) and Hajela (2002).

In June 2001, the sales of all manufacturing companies grew at a low pace of 5.9 per cent, the lowest quarterly performance since June 1998, and the growth rate of profits was around 9.3 per cent as compared to 20 per cent in 2000.

The Prime Minister while addressing the National Development Council (NDC) meeting presented this agenda. See “Reforms and Difficulties in the wake of the Tenth Plan: Rhetoric”, as reported in the Hindustan Times, September 2, 2001, New Delhi.

For details see Mishra and Puri, 2001, Chapter 34, pages 569-72.
See Ninth Five-Year Plan, 1997-2002, Planning Commission, Government of India, Volume II, page 604.

See Seventh Five Year Plan, 1985-90, Planning Commission, Government of India, Volume II, page 98.

For example, in a press report of The Times of India, June 27, 2002, New Delhi/ Chandigarh, it was reported that “more than 80 per cent of the units in the District of Gurdaspur in the State of Punjab have perished over the years” and “more than 700 small units in the district were on the verge of closure.”

See Seventh Five Year Plan, 1985-90, Planning Commission, Government of India, Volume II, page 98.


Anand, Vinod K. (1999), “Informal Sector and its Role in Employment Creation in Developing Countries”, The Asian Economic Review, Vol. 41, No. 3, December, Hyderabad, India
- Anand, V.K. (2001A), “Development Planning in India: Anatomy of Past Experience and the Way Forward”, The Indian Journal of Economics, Vol. LXXXI, Part III, No. 322, January, University of Allahabad, India.
- Anand, Vinod K. (2001B), “Trickle-Down Versus Trickle-Up: The Controversy and Rationales”, Mainstream, Volume XXXIX, Number 27, June 23 New Delhi, India.
- Economic Survey (2001-2002), Government of India, Ministry of Finance, Economic Division.
- Galbraith, John Kenneth (1987), Economic Perspective: A Critical History, Houghton Mifflin Company, Boston, Massachusetts.
- Grootaert, C. (1992), “The Position of Migrants in the Urban Informal Labour Markets” in Cote d’Ivoire, Journal of African Economics 1:3 (November).
- Hajela, P.D. (2002), “Institutions: The Economic Approach”, Indian Institute of Advanced Study, Shimla, India
Kavuluvulu, Kakwiza (1990), “The Informal Sector; Panacea, Malaise or Cul-de-sac?” Sapem. 3:12 September.
- Mazumdar, Dipak (1989), “Microeconomic Issues of Labour Markets in Developing Countries; Analysis and Policy Implications”, EDI Seminar Paper Number 40, Economic Development Institute of the World Bank, Washington D.C.
- Misra and Puri (2001), Indian Economy: Its Development Experience, Himalaya Publishing House, Bombay.
- Rempel, Henry., Anand, Vinod K., Sunny, Grace., Babikanyisa, Vincent., Siphambe, Happy., Morewagae, Boitumelo S. (1994), “The Place of Non-Formal Micro- Enterprises in Botswana: A Study of Selected Urban and Semi-Urban Areas”, Mimeo. Department of Economics, University of Botswana, mimeo. page 8.
- Thomas, J.J. (1992) Informal Economic Activity, Hemel Hempstead, Harvester Wheatsheaf.
- Vandemoortele, Jan (1991) “Employment Issues in Sub-Saharan Africa, African Economic Research Consortium, Initiatives Publishers, Initiatives Ltd., Nairobi, Kenya.

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