Informal economy: the only path?

SOURCEBusiness Recorder
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“Wage jihad against the four ills of our country: poverty, illiteracy, injustice, and corruption” was the PM’s New Year resolution. Who could disagree? Not even those who look to the skies for a sliver of solid thinking to translate PM’s noble intentions into government’s actionable plans.

The PM’s other sound bite, flavour of the season, is wealth creation. We no longer hear much of the welfare state. He seems to have crossed the Rubicon – to march on to the gates of capitalism. ‘Trickle-down effect’ theory seems to have convinced him that the poor will become less poor only if the rich become richer.

As he looks at our murky economic firmament, the only shining star he can find is the Field Marshal. What resonates with him is the Ayubian model, crafted by experts from the US and funded by foreign inflows (plus some brazen exploitation of the Eastern wing?)


The trouble is the Ayubian model was a package deal: a Foreign policy that was in sync, an authoritarian rule, and the ‘steel frame’ of the civil service. Despite the freedom afforded by the Presidential form to choose whoever he wanted to he relied almost wholly on Federal Secretaries. Also, in those early days there was a lot of low hanging fruit.

How much of that can Imran replicate? What kind of resources, human and financial, can he marshal to wage his worthy jihad? When he leans on the example of China in pulling millions out of poverty and illiteracy (though not necessarily injustice and corruption, in the classical sense) does he know what it took, besides the one child diktat? Does he have a clear vision, rather than a zigzagging one influenced by the Ayub here and antidotes from there?

There is sufficient evidence to suggest the Ayubian model created wealth – consistently high GDP growth and rising per capita incomes – but there is equally compelling evidence of growing inequalities, both regional and individual. Mahbub-ul-Haq was not the only economist leading the charge against ‘trickle-down-effect’ of wealth creation; even its archangel, the World Bank, had to abandon the theory.

Welfare state and wealth creation are not inherently antagonistic. To the contrary, they can have a symbiotic relationship: wealth generating public welfare and welfare lending sustainability to wealth creation.

The challenge is in designing policies that get the wealth-welfare blend right. Where you get it right you have more inclusive, more caring, societies. Where you don’t get it right you end up either with a weak economy or an exploitative system, both symptoms of a failing state.

Also Read: Stagflation likely to hit Pakistan’s economy soon

If there is one area this government-by-task forces should investigate is how we have ended up with both – a weak economy as well as an exploitative system. Is there something amiss in our wealth creation model where businesses keep hollering for more government help (while building personal fortunes) and the informal sector keeps growing relentlessly?

Does a large and growing informal sector signal an ailing economy? Not necessarily, some would argue. They consider informal sector to be generally more efficient – “the site of most entrepreneurial aspects of urban economy”. Often people ‘choose’ it for greater freedom and flexibility. Working from home, or having a small self-owned enterprise where you are the boss, can have its own charm.

Those who ‘choose’ to stay out of the formal sector generally do so to stay under the radar of regulations and taxes. The ‘moonshining’ element, where you have a tax-free and regulation-lite job or business on the side, adds to the lure of informality.

In the developing world things are fundamentally different, as succinctly captured by De Soto (The Other Path). Here it is force of circumstances, rather than a preferred choice, that propels the informal sector. It is more than a sign of an economy not growing fast enough to absorb the unemployed millions.

Except for a few everyone is a loser. The ‘informal’ have erratic earnings and are denied social benefits provided by government or employers. The government loses taxes. Consumers are at risk when protective regulations are evaded. The formal sector faces unfair competition.

For the developing world, informality is a social ill. The modernization school of development – informality will disappear with economic progress – is left licking its wounds.

Because it is unreported, it is hard to measure informality, or grey/shadow/parallel economy. Large variations in size-estimation become unavoidable. Researchers are obliged to use proxies and approximations.

Between the ILO and SBP estimates, it will be fair to put the size of informality in Pakistan at a minimum of 50% of GDP. Put another way, Pakistan’s GDP will grow from the official $300 billion to $ 450 billion if the informal economy were to be incorporated!

More pertinently, informal sector is our escape from extreme poverty. It is fed by economic marginality, an involuntary exclusion from the formal sector. The number of people it employs, something like 75% of our total non-farm workforce, underscores the enormity of the problem – as also inadequate policy responses.

Taxation and regulation revamping, that is otherwise badly needed, will be an insufficient policy response to growth of informality, which in our case is driven almost entirely by push, not pull, factors.

Nor would incentivising labour intensity in our private enterprises solve the problem – it could well impair productivity without commensurate job creation. ‘High Pressure Economy’, where firms are obliged to compete for available workers rather than workers competing for job openings, is a distant dream.

There are no indications that tackling the informal sector is a priority with the government. It seems to want to just muddle through; happily unaware of how one policy negates another. Informal sector is destined to fall through the cracks between the wealth and welfare rhetoric.

Even if the government miraculously succeeds in its lofty ambition of providing ten million jobs and five million housing units will it be sufficient to meaningfully dent informality? Are there any supporting policies in the works to contain the growth of informality? Or, have we decided to live with it?

Poverty, illiteracy, injustice, corruption will not go away if informal sector remains the only path for people to eke out an existence. The jihad won’t succeed if informality persists – and it will be a mistake to treat informality as a sub-set of macroeconomics. Informality containment needs special therapy. 

(This news/article originally appeared in Business Recorder on January 10th, 2019)

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