India’s Informal Economy is Growing, But Jobs Aren’t

India is one of the fastest-growing major economies in the world, known for great strides in digital payments and smartphone penetration, and yet behind the image of a modern economy lurks a painful truth about employment growth in its informal sector, which employs around 80-90% of its workforce. A new report published by the United Nations University World Institute for Development Economics Research (UNU-WIDER) in Helsinki, Finland, which studied job data from 2010-11 to 2023-24, puts the spotlight on a worrying phenomenon in this field: the rise in the number of enterprises, which are micro, small and medium, has not translated into growth in employment.

This recent paper, titled “What constrains the performance of enterprises in India’s informal sector?”, penned by professors Rajesh Raj Natarajan and Kunal Sen, examines the difficulties that informal enterprises continue to face in the country.

“The results show that the sector has expanded but that this expansion is largely driven by a rise in the number of enterprises, while the growth in employment and value addition remains limited. Although firm performance has improved over the study period, the pace of progress has slowed and substantial differences across firms persist,” the paper notes, emphasising that constraints do not affect all firms in the same way. It points out that the importance of demand-related constraints has increased over time and they are closely linked to weaker performance. It, however, adds: “In contrast, supply-side constraints have receded in importance. The findings point to the need for policy responses that account for differences across firms and the changing nature of constraints.”

That the number of firms has grown much faster than employment indicates that many new enterprises are very small and generate limited additional employment. Much of this enterprise growth appears to be driven by people creating their own livelihoods rather than by the expansion of successful businesses, the authors highlight. “For many, self-employment may be a response to limited wage employment opportunities,” Natarajan told Open in an interview.

In fact, the paper stresses that a decline in demand is the most important constraint facing informal enterprises. Obstacles such as finance, power supply and raw materials remain important, but a growing number of firms report falling demand for their products and services.

As is well known, the informal sector is highly heterogeneous in composition. Natarajan and Sen say that while some firms are relatively productive and successful, many others find it difficult to survive, adding that performance varies considerably across different categories of firms and entrepreneurs.

According to the report, female-owned enterprises and firms run by socially disadvantaged groups generally perform worse than others. Women-owned firms and firms owned by SC/ST entrepreneurs consistently show lower productivity and weaker performance indicators. This, notes the paper, suggests that social and economic inequalities continue to influence business outcomes.

The peer-reviewed study says that firms that maintain accounts, use digital technologies, operate from fixed premises or employ hired workers tend to perform better. Natarajan hastens to add, “Many enterprises remain informal because it is economically rational under existing circumstances. The qualitative interviews show that entrepreneurs often remain informal consciously because margins are low, compliance costs are high and uncertainty is substantial.”

However, the paper says that despite mounting challenges, informal entrepreneurs display considerable resilience. They continuously adapt to changing market conditions, adjust their business strategies and find ways to sustain their livelihoods, it states. Yet the persistence of tiny, low-productivity enterprises alongside a relatively small formal sector suggests that the transition from low-productivity to high-productivity employment remains uneven and incomplete.

What the authors argue is that the informal sector should not be viewed as a marginal part of the economy anymore. It remains central to employment generation and livelihoods for a large share of the population, they note. Different types of informal enterprises face different challenges. As a result, policy interventions need to be tailored to the specific needs of different groups of firms rather than relying on a single approach for all, the report says. The authors say that the most powerful single takeaway of the study is that India’s informal economy is growing numerically, but that growth does not necessarily represent productive transformation.

Another study published by the two authors earlier this year focused on how caste influences productivity in small firms in the informal sector. It said that exclusion from business networks continues to hurt entities owned by Dalits and tribals, in sharp contrast to firms owned by disadvantaged ethnic groups in countries like the US and the UK, where new policies have produced results.

“The persistent form of exclusion, with marginalised groups largely confined to low-capital, survival-oriented sectors, points to a divergent trend (compared with countries in the West, where racial problems persist),” said the paper titled “Behind the Numbers: Exploring Caste Inequities in Entrepreneurial Success”, authored by economists Rajesh Raj Natarajan and Kunal Sen. The study used enterprise-level data from the Government of India’s National Sample Survey Office (NSSO) surveys of unincorporated non-agricultural enterprises in 2010-11, 2015-16 and 2023-24.

In fact, an earlier study by the two authors in collaboration with Simone Schotte and published by the United Nations University in 2020 had said that upward mobility for unorganised workers was far less than expected, with women and lower castes facing enormous hurdles and being confined to what the report called “dead-end” work status. That report by UNU-WIDER analysed the transition of jobs between India’s informal and formal sectors during the high-growth period between 2004-05 and 2011-12. During the period studied, the Indian economy grew at an average of 8% per year.