Viewpoint: Formalising the Economy

15 NOV,2021 | MEDC


  • Many initiatives of the government over the past several years, as well as the impact of the pandemic are believed to have enhanced the formalization of the Indian economy. The demonetization which occurred five years ago (on November 8, 2016) and the subsequent cash shortages pushed many Indians to adopt digital modes of payment. The implementation of GST a year later, also brought a large number of firms into the formal system. However, many small businesses were unable to comply with the rules and benefit from them. They were the losers in the new scheme of things. Covid also had a disproportionate impact on the informal sector, thus further widening the existing inequalities.
  • The major component of the Indian economy continues to remain the unorganized sector. It employs over 90% of the workforce. It essentially consists of agriculture and MSMEs which work with cash rather than through formal banking channels. While Covid affected the organized sector through the demand side (as people lost jobs and incomes), demonetization made it difficult for the unorganized sector to function without cash. However, there still remains no globally accepted framework to gauge informal activity in the economy.
  • Greater formalization of economic activity has its benefits, chiefly in the measurement of important macro indicators used as policy inputs. At the micro level, it will enable small businesses to create their digital presence, which would facilitate credit access to them. Several new age financial technology firms are today assisting smaller businesses to access credit more efficiently. Even though increased digital transactions and other policy interventions have apparently enhanced the formalization of the Indian economy, measuring its precise extent will need further study. We need to remember that digitalization and formalization can help maintain the growth momentum, but they will not be the primary drivers of socioeconomic development.
  • Digitalization and formalization of the economy often go together. But digital solutions cannot be achieved in isolation. Policymakers must urgently make the implementation of digital technologies an element of a larger ecosystem of innovation, which will also assist in speeding up the formalization of the economy. Well-calibrated regulatory frameworks, strategic investment in infrastructure, higher education and training, and financial inclusion must all take policy precedence, and should all be developed concurrently.
  • The concerted attempts made recently at formalizing and digitalizing the economy also mean that policymakers should be aware of and address the complex legal and ethical issues pertaining to the spread of technology in a relatively conservative society. This includes data privacy and tax evasion concerns. And this is especially true in India, where institutional structures may not always be robust enough to uphold the rights and interests of the most vulnerable sections of society against those of market forces.
  • The deep disruptions generated by Covid have created subtle opportunities to change the system. This crisis contains the seeds of a large scale re-imagination of India’s socioeconomic structure and service delivery mechanisms. Apart from key areas like the promotion of local industry and the upgrading of urban infrastructure, the pandemic has also accelerated macro trends in the digitalization and formalization of the economy. Policymakers need to optimize them.

*Photo Credit: Google


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