Growth of Informal Sector in India!

Quite recently the Indian economy has been characterised by the slow growth of the commod­ity producing (primary and secondary) sectors and faster growth of the service (tertiary) sector. At the same time we have found a dichotomy in the secondary and tertiary sectors—the co­existence of formal and informal sectors. The dynamism of the informal sector in LDCs like India underscores its importance for employment.

Characteristics of Informality:

Informal enterprises are often characterised by ease of entry; the use of local resources; family ownership; small scale; labour intensive adapted technology; informally acquired skills; and relatively unregulated, competitive markets. The informal sector is mainly located outside of (or antagonistic to) government regulation. But this is not always so.

Some firms do act in accordance with government regulations. Some may evade them and in some cases the government may actually try to enforce regulations on small firms. Firms may comply with some but not other regulations.


Perhaps the most useful, and common, distinction between the two sectors has to be with the number of employees in a firm. But this yardstick loses its relevance in case of professional services such as doctors and lawyers. Yet it is a good general reference point.


A good way to envision the informal sector is through some of its activities. In the airport often a child wants to carry the bags of a visitor, shine his shoes, be his guide, or sell him food and inexpensive manufactured goods and buy foreign exchange with Indian currency (rupees).

A child often offers a service such as watching one’s car for a small sum while the owner is parking it on the street’. Such small-scale ‘street’ services are not only the most visible but also the first line of entry for many into the informal labour force.


The informal sector consists mainly of small, family-owned firms that operate outside of, or on the fringes of, legal standards established for other firms. The informal sector is usually an important source of employment in developing countries like India.

Typical activities include:

Services: tailoring, hair dressing, making loans, machinery repair.

Commerce: retail sector, restaurant, lodging.


Manufacturing: food processing, textiles and clothing material, processing, brewing.

Construction and repair of houses and flats.

Transportation: taxis, buses.

Miscellaneous: recycling, various illegal and immoral activities.

Because informal firms operate outside some government regulation, often employing fam­ily workers, wages are low. Because they may have a harder time getting loans, and rely on informal financing, capital costs are higher. The lower wage-rental ratio, combined with smaller scale, explains why more firms are relatively labour-intensive in nature and operate with sim­pler technology.

The Informal Sector and Small-Scale Industries:

The informal sector is important because of the size distribution of firms in developing coun­tries. If we define a small firm as one with fewer than ten employees and a large firm as one with more than 50, industrialised countries tend to have a positive correlation between the number of firms and their size. In developing countries like India, there tends to be a large number of small and large firms, with relatively few in-between.

There are a number of reasons for this. Small, fragmented markets, high transportation costs, little access to capital and the prominence of labour-intensive industry such as food processing and apparel tend to keep down the size of firms. Once these barriers are overcome, firms can become quite large.

In addition, a high degree of government regulation is also a factor. The cost of regulations frequently discourages the firms from crossing the invisible line that separates informal from formal while the large firms are better able to withstand those costs; thus, there are few mid-range firms.


Small firms are not necessarily inefficient. Given their technology, small firms in LDCs seem to be as efficient as those in high-income countries. Industries where small-scale predominantly shows ease of entry and exit (especially where regulations are not excessive), and many more firms match the efficiency of established firms in a few years, medium-sized firms do not have scope to emerge and survive.



Informal firms provide some services that are otherwise not available at all or are available to only a small part of the population through the formal sector. They fill in the cracks by providing ancillary services (such as transportation and, repair work) that permit the formal sector to provide a variety of services to individuals who work in the formal sector. Sometimes they may work directly for formal sector enterprises, through various types of subcontracting arrangements.


Informal firms are an extremely important source of inexpensively acquired skills including managerial and organisational skills. As a sort of informal business school and vocational institute, they are often the only source of training available to poor workers in LDCs like India.

Pay tends to be below similar jobs in the formal sector, but heads of informal enterprises (sometimes the only employees as well) often earn more than the average wage in the formal sector through a combination of return to both labour and capital.

Informal firms may compete with some formal firms, especially in services, transportation and insurance, but they also provide strong backward linkages to the formal sector by purchasing their machinery and raw materials.



Informal finance through moneylenders and co-operative organisations formed by poor people are crucial. In both rural and urban areas, there are informal rotating credit organisations in which funds are contributed by members and are available to them either on a regular basis or as needed.


Most activities and transactions in the informal sector are not officially recorded. A plumber may repair one’s wash basins and collect Rs. 50 as his remuneration which often passes unnoticed by the taxing authorities. So growth of the informal sector creates two problems—undervaluation of national income and accumulation of black money.