Informal economy and economic inclusion Policy options for Bangladesh

Updated on 18/02/2020 - By InM - No Comments

The Daily Star

Mustafa K Mujeri

The definitions vary globally, but essentially the informal economy means economic consists of activity that takes place outside the formally regulated structures. Typically, informal economic enterprises are small, often based around households. These usually do not pay taxes, nor do they enjoy social protection. While their activities are not necessarily illegal, they are not covered by the framework of national laws in the country.

Importantly, there is not always a clear divide between formal and informal economies; for example, sometimes people may work cash in hand for formal, registered businesses. So defining informal economic activity can be difficult. And if the informal economy is hard to define, it is even harder to measure. But we do know that it is very big, especially in Bangladesh. According to BBS Economic Census 2013, out of a total of 7.82 million enterprises in the country, 7.81 million (99. 8 percent) are small and micro (including cottage) enterprises, most of which belong to the informal economy. In Bangladesh, the informal economy plays an important role both in employment generation and in production and distribution of goods and services. The informal sector activities are mostly small in size and transient in nature.

For the labour market, informal employment is a job-based concept and encompasses those jobs that generally lack basic social or legal protections or employment benefits. The operational definition adopted by the BBS for informal employment is a combination of both the informal character of the individual job and employment in the informal sector. According to the Labour Force Survey (LFS) 2016-17, out of the total 60.83 million employed labour in the country, 85.1 percent work in the informal sector; females are more involved in informal activities (91.8 percent) relative to 82.1 percent for males. In both rural and urban areas, females and youths (aged 15-29) are more likely to be in informal employment.

In 2017, a total of 51.7 million people was engaged in informal employment; of them 31.0 percent were 15–29 years old, while 64.9 percent were 30–64 years old, and only 4.1 percent were 65 or older. There exists a clear negative correlation between higher educational attainment and informal employment i.e., highly educated persons are more likely to be in formal rather than in informal employment. It is seen that nearly half of those who are engaged in informal employment have no schooling while only a small fraction (less than 0.5 percent) has received any vocational/technical/skills development training. Further, protective labour regulations and unions do not cover informal sector employment.

The informal sector accounts for around 40 percent of the total gross value added, with the highest contributions in agriculture, fisheries, trade, and industries (micro, small, and medium enterprises, MSMEs) where capitalisation is relatively low. Over the years, there has not been much change in the level of informality. In 2000, 75.2 percent of employment has been informal, and the share rose to 85.1 percent in 2017. The rising share of informal employment, however, is not due to declining levels of formal employment, but due to more rapid growth in informal employment than formal jobs.

Alternative views on informal labour market

There is an ongoing debate on whether informal sector employment is a result of competitive market forces or labour market segmentation. More recently, it has been argued that the informal sector shows a heterogeneous structure. For some workers, the informal sector is an attractive employment opportunity, whereas for others—rationed out of the formal sector—the informal sector is a strategy of the last resort.

The dualists have a posit view towards the informal economy and consider the informal sector as a tangential or marginal occurrence that results when there is an inadequate amount of jobs in the formal economy; and this will recede with the development of the modern sector. The structuralist school perspective does, however, view the informal economy as a means to reduce labour and capital costs by subordinating small informal producers and traders into completing tasks, creating competitiveness.

On the other hand, the underground economy approach views the informal sector as downgraded labour who receives lower wages, fewer benefits in addition to inferior working conditions in comparison to individuals employed in the formal economy. The legalist school does, however, have a rational response regarding the absence of over-regulation of employees of the informal sector as they are able to avoid governmental regulations and bureaucracy, reducing costs and promoting wealth creation.

Nevertheless, the development and magnitude of informal employment has been traditionally credited to the displacement of workers into insecure forms of labour market attachment as the only feasible alternative to unemployment. The informal economy rotates around a variety of economic activities that evade costs; additionally, all these activities are excluded from not only the benefits and rights incorporated in laws but administrative ruling and commercial licensing. Thus, this sector not only has little to no social protection or employee benefits but undermines the principle of inclusiveness within the labour market.

Moreover, the feminisation of poverty combined with prejudice with regard to gender, age, ethnicity, or disability implies the most exposed and marginalised groups tend to end up in the informal economy. This is especially true for women and young people especially since informal employment is the standard condition amongst most youths in Bangladesh. Consequently, a significant disadvantage of working in the informal sector rotates around a lack of economic security. Economic insecurity defined by several factors, irregularity of income, pricing skills as well as a low-income customer base. Dealing with unprincipled employers is another familiarity when dealing with the informal sector.

Eminence of informal economy in Bangladesh

The eminence of the informal economy in Bangladesh derives from the promise it offers of generating a reasonable source of income for the most vulnerable populations. The informal economy has become an important characteristic of all sectors, with economic units employing millions of workers. All sectors in Bangladesh are characterised by dualistic structures, i.e. the prevalence of formal and informal activities. The LFS 2016-17 shows that 95.4 percent of all employment in the agriculture sector is informal employment, followed by 89.9 percent in industry sector and 71.8 percent in the services sector. Further, informal work covers a vast spectrum of activities, ranging from fairly basic survivalist labour to sophisticated and skilled craft work.

What induces entrepreneurs to hire contract workers? Major suspects are the rigid labour regulations, increasing import penetration leading to substitution of regular workers by contract workers due to lower wages of the latter, and effect of staffing companies. Further, formal firms may hire more contract workers to curb the bargaining power of regular workers for keeping their wage demand in check and use them as an alternative workforce to their strategic advantage against unionised regular workers.

Employees of the informal economy are not protected by law and as a result stand at risk of being exposed to different forms of abuse and exploitation. Additionally, expansion of this sector potentially has the ability to intensify problems connected with slums, congestion and health already plaguing the major cities in the country. Furthermore, informal economic activity severely limits tax revenues, most in need for a stable tax base in Bangladesh.

Technology as the driver of economic inclusion

In the coming years, the present 4IR will bring an unprecedented pace of technological change, building on the digital revolution to combine technologies and transform systems, production structure in agriculture and other sectors—including the Bangladesh society itself. For Bangladesh, advances in computing power, connectivity, artificial intelligence (AI), biotechnology and GIS, and more capable technologies hold tremendous promise of generating decent employment, especially in the rural areas. This will accelerate inclusive agriculture, rural growth and structural transformation to high-productivity agriculture and rural nonfarm activities. One key policy for realising the positive outcomes of 4IR is to bridge the widening gap between skilled and unskilled labour. For reaping the benefits of technology, the key will be to transform the country's rural economy and create skilled jobs in rural areas. The need is to ensure more investments in transportation, power, and internet access to create more employment for women and youth in the rural areas.

Agriculture and food processing represent an untapped reservoir of opportunities for the rural youth for economic inclusion. While local and regional demand for food is rising, the scope for developing and integrating rural youth into the local value chains remains largely underexploited. Most rural youth engaged in agriculture are currently involved in production and very few are involved in downstream activities in the value chain. There are many reasons why investing in local value chain development in the agri-food sector could become an engine for decent job creation and food security. From a rural perspective, local food processing is compatible with the relatively low level of skills possessed by the rural youth, and is more likely to remain located in small towns and rural areas to ensure proximity to the production source. Additionally, it can create strong forward and backward linkages with other food and non-food system activities, paving the way for a virtuous cycle of territorial development.

The labour market's major problem is not a shortage of jobs; it is the shortage of employable skills. The speed of a nation's development is directly related to the quantity and quality of vocational skills possessed by its workforce. The wider the range and the higher the quality of vocational skills, the faster is the growth and more prosperous the society. The availability of employable skills is one of the major determinants of how readily new job seekers find employment. The very low level of employable skills makes the search for work much more difficult. It reduces the market value of the job seeker and adds to the costs of employers who must train new recruits from scratch.

Innovations and skill development in informal economy

There is certainly a lot of innovation going on, and it takes many different forms in the informal sector. For the metalworkers in Bangladesh, it is often a case of reverse engineering products sold by formal businesses and working out how to make cheaper alternatives from available materials. But there is also some brilliant high-end creative work. The informal manufacturers are innovative not only in terms of new products they come up with but also in the way they market those products—through attractive, distinctive packaging and other types of branding.

There is a diverse range of innovation, but one can also identify some important common points. For example, as in the formal economy, geographical concentration is noticeable. Activities tend to focus in certain areas so that one can identify innovation clusters (e.g. light engineering in Bogra). Indeed, there is often some overlap between formal businesses and informal businesses or workers within a cluster.

Usually, there are ways of regulating knowledge flows and intellectual property (IP) in the informal economy. While these are not the same as formal IP mechanisms, they show some similar features. For example, if a worker within a cluster invents a new product or a new way of doing something, they can enjoy a competitive advantage for a while by being the first to produce or use it, but they will be expected to share it with their peers in due course. That sort of period of near-monopoly followed by the mandatory sharing of knowledge is essentially the same idea that underlies the patent system and other IP systems. So there is a real sense that informal workers often have their own informal IP rules.

Moreover, through an increased income as a result of economic engagement in the informal economy, many  entrepreneurs are able to save earnings hence aiding in the transformation from informal to formal activities. Additionally, employees in the sector often receive good pay as their employers have no tax obligations. What is more, employee effort in this sector of the economy is often directed towards achieving a loyal customer base through producing the best goods and/or services. Furthermore, auxiliary positive effects of the informal economy consist of a reduction in the crime rates, reduction in rural to urban migration, a reduction in poverty levels as well as the construction of an appropriate base for apprenticeship training. However, many informal entrepreneurs have no access to banking facilities or collateral as a means to secure a bank loan.

Given the overwhelming dominance, skills development in the informal sector is an issue of great importance for Bangladesh. It concerns almost all the sectors in the economy. For ensuring greater efficiency and higher productivity, it is necessary to develop technical and vocational skills for these young people and other stakeholders in the sector. The informal apprenticeship programmes that currently exist in the informal sector have better external efficiency although it costs about three times less than formal training courses.

Skills development in the informal sector means focusing on the needs and capacity building of the MSMEs. The skill development initiatives for enhancing skills improvement in the informal sector are no doubt challenging tasks. There is over six million children out-of-school in Bangladesh who have either dropped out of or were never enrolled in schools. Most of these children are engaged in informal employment, as unskilled labour, involved in hazardous or non-hazardous, paid or unpaid work. These children, especially from the large urban slums have to be given an opportunity to not only complete courses in non-formal basic education but also stream into training on livelihood skills. Still, informal skills development remains outside the scope of government programmes. A large number of NGOs—both large and small—have adopted various programmes of skilling young people, especially from the marginalised and disadvantaged sections of the society.

In Bangladesh, the Directorate of Technical Education (DTE) and the Bangladesh Technical Education Board (BTEB) have been adopting different models towards skill training delivery options for the disadvantaged, particularly for the working children. It is expected that these models will be institutionalised through government-run vocational training centres. Supervised informal apprenticeship model has been designed to deliver livelihood skills training to out of school children with low level of educational qualification (depending on trade). This innovative intervention ensures that 14+ years aged urban working children have the opportunity to acquire competency-based skills under a trade-based master crafts person (MCP) who is based in a local market.

Formal work environment in Bangladesh is also undergoing rapid transformation in the context of globalisation and technological change, leaving the majority of the workforce in the informal sector, composed of non-farm or off-farm rural activities and work in family-run micro-enterprises. The informalisation of the labour market with changes in the concept of employability risks exclusion from employment for those without appropriate skills. Further, the rapid expansion of the country's informal sector is an outcome of the inability of the formal sector to generate adequate employment opportunities.

Although the informal and modern economic sectors are closely interdependent and have many forward and backward linkages, the organised sector in Bangladesh has never provided a very large employment base. According to the Labour Force Surveys, the growth of formal sector employment has been very slow over the years. Most of the additional labour force has been absorbed in the informal sector. Therefore, the changing concept of employability requires an innovative approach to education, training and skill development for the informal sector. One of the principal development challenges for Bangladesh is the creation of employment for new entrants into the labour force, most of whom are underemployed.

A policy agenda for Bangladesh

In theory, the government has several policy options for dealing with informality: it can choose to do nothing about it, or it can seek to reduce it either by deregulating the formal economy or by facilitating formalisation. In reality, the negative impacts of doing nothing mean that interventions to tackle informal employment are required. Deregulation means reducing taxes and state regulations that apparently forces up labour costs and prevent flexibility, and which thus act as a disincentive to formalisation. However, there is little evidence that reducing taxes and deregulating the formal economy reduces the informal economy.

Given the problems that informality poses, a policy to eliminate the informal economy is a daunting challenge. It would simply be unrealistic in Bangladesh, where over 85 percent of the labour force works informally—mostly for a subsistence-level livelihood and for want of alternative employment. The point of the policy aimed at reducing informality is not so much to eradicate it per se as to bring informal workers and enterprises within the sphere of formality. The objective is indeed the growth of the formal economy, decent work, fuller employment and increased tax revenue for the government. The efforts should therefore be not only shifting informal workers into formal jobs, but also registering and taxing formalised enterprises, providing informal workers with benefits such as access to legal and social protection as well as support services (e.g. skills or business training), and enabling them to participate in collective bargaining processes.

The policy measures available for promoting formalisation may be divided into a hard compliance approach and a soft approach that seeks to foster a culture of commitment to acting lawfully, including through the pursuit of broader development objectives. In the hard compliance approach, deterrence measures and/or making formalisation beneficial and easier are used both to prevent businesses and labour from entering the informal economy and facilitate the formalisation of businesses and labour already in the informal economy. The intention is to change the terms of the cost/benefit trade-off confronting those engaged in or planning to join informal employment.

The deterrence approach concentrates on the cost side of the trade-off by increasing the perceived or actual likelihood of detection and penalties and sanctions for those who are caught. Policy measures might include enforcing the obligation to register all new workers with a social security agency prior to their first day at work, increasing labour inspections, strengthening or creating new monitoring agencies, improving cooperation between agencies and increasing the penalties for offenders. This, therefore, constitutes a "negative reinforcement" approach, using punitive measures to elicit behaviour change among those not in compliance. The evidence on whether this approach works is mixed. Although some find that improving detection and/or penalties does reduce informal employment, others find that informal employment actually grows in the face of such policies.

Rather than increasing the cost side of the trade-off, recent policies have given more attention to making it beneficial and easier to formalise. Firstly, preventive action can be taken against non-compliance, notably by simplifying regulatory compliance, introducing new categories of legitimate work, providing business support and advice, giving direct and indirect tax incentives, and developing initiatives to smooth the transition to formal self-employment. Secondly, measures can be taken to facilitate the formalisation of those already in informal employment. Such "remedial" action can include business advisory and support services to those seeking to formalise their endeavours, and a variety of targeted direct or indirect tax incentives encouraging the use of declared rather than undeclared work.

The hard approach thus assumes that participants in the informal economy are rational economic agents and that it is simply a case of changing the cost/benefit ratio confronting them. The soft approach focuses on developing a culture of commitment to being lawful so that "sticks-and-carrots" are no longer required. In other words, it shifts the policy focus from direct to indirect controls. Specific policy measures include educating people into the benefits of formality and not evading labour laws, running awareness campaigns about the benefits of formality, and promoting procedural justice and fairness among tax and social security offices and labour directorates.

What is clear is that informal economic activities are highly diverse and there is no one-size-fits-all policy to support the development of formal businesses. In order to truly change the living conditions of the populations of Bangladesh, it is essential that the government not only realise but take advantage of the hidden potential within the sector. The people in Bangladesh are natural innovators in lots of different ways; we need to understand that and help them make the most of it.


Mustafa K Mujeri is Executive Director, Institute for Inclusive Finance and Development (InM). Email:

The Institute for Inclusive Finance and Development (InM) is registered as an independent non-profit institution under the Societies Registration Act 1860.
The Institute works for developing the overall capacity of the financial sector and strengthening the links between the financial and real sectors through undertaking research, training, education, knowledge management and other programmes in priority areas including inclusive finance, microfinance, poverty and development.

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