Informality in the formal economy of Bangladesh

Updated on 06/03/2019 - By InM - No Comments


Mustafa K. Mujeri | Published:  March 05, 2019 21:26:12 | Updated:  March 08, 2019 21:32:45


Globally, the definitions vary, but essentially informal economy means economic 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 protections. 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 a country like Bangladesh. According to BBS Economic Census 2013, out of a total of 7.82 million enterprises in the country, 7.81 million (99. 8 per cent) are small and micro (including cottage) enterprises, most of which belong to the informal economy.  

Informal  employment  is  a  job-based  concept  and  encompasses  those  jobs  that  generally  lack  basic  social  or  legal  protections  or  employment  benefits  and  may  be  found  in  the  formal  sector,  informal  sector,  or  households.  The operational definition adopted by the BBS (Bangladesh Bureau of Statistics) 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, 51.73 million (85.1 per cent) work in the informal sector; females are more involved in informal activities (91.8 per cent) relative to 82.1 per cent for males. In both rural and urban areas, females and youths (aged 15-29) are more likely to be in informal employment. Over the years, the share of informal employment has not declined much; it was estimated to be 87.5 per cent in 2010. 

There is an ongoing debate on whether informal sector employment is a result of competitive market forces or labour market segmentation. More recently, it is 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 positive 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, has 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 also 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 the circumstances 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: 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 per cent of all employment in the agriculture sector is informal employment, followed by 89.9 per cent in industry sector and 71.8 per cent 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 work force to their strategic advantage against unionised regular workers.

Employees of the informal economy are not protected by law and as a result stand at the risk of being exposed to different forms of both 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.

There is certainly lots of innovation going on, and it takes many different forms in the informal sector. For the metal workers 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 a 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 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 bank loan.

POLICY OPTIONS FOR DEALING WITH INFORMALITY: 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 of today, where over 85 per cent 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 formalization 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 behavioural 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 population of Bangladesh, it is essential that the government not only realises but also takes 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.

Dr. Mostafa K Mujeri is Executive Director, Institute for Inclusive Finance and Development (InM).

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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