Formalization of Indian Economy

The formalization of Indian economy is a transformative shift marked by a process redefining job structures, employment security, and social benefits for millions. Read here to learn more.

India’s economy is currently undergoing a transformative shift marked by an increasing trend toward formalisation, which is redefining job structures, employment security, and social benefits for millions.

This change is of profound importance for India’s workforce, as it ensures that a larger segment of the population is covered by social security systems, offering them greater economic stability and a more secure future.

The Employee’s Provident Fund Organisation (EPFO) stands as a vital institution in this journey, managing a long-term savings scheme and social security benefits for salaried workers nationwide.

By tracking and supporting the formalization process, the EPFO not only provides critical financial safety nets but also plays a pivotal role in transitioning the workforce toward a more organized and protected structure.

What is the Formalization of Indian Economy?

Formalization is when jobs move from the informal sector (small, unregistered businesses and daily wage workers) into the formal sector (where employees have contracts, job security, and access to benefits).

• In the formal economy, workers enjoy legal protections like a fixed salary, healthcare benefits, paid leave, and retirement savings.
• This change is crucial because it ensures that more people are covered by social security systems, making their lives more stable and secure.
• In simple terms, formalization means bringing more workers under the umbrella of government regulations and benefits, so they are not left vulnerable to economic ups and downs.

Key Aspects of Formalization:

• Informal Economy: Economic activities that are not regulated by the government and do not comply with labour laws, tax obligations, or social security standards.
• Components of Formalization:
  • Business Registration: Encouraging unregistered businesses to formalize their operations.
  • Tax Compliance: Expanding the tax base by bringing more entities under the tax net.
  • Labour Formalization: Providing employees with contracts, social security, and adherence to labour laws.
• Benefits:
  • Increased government revenues through taxes.
  • Better job security, social protection, and working conditions for employees.
  • Enhanced access to credit and markets for businesses.
  • More reliable data for policymaking.
• Challenges:
  • Resistance from small businesses fearing higher costs and taxes.
  • Lack of awareness or access to formalization mechanisms.
  • Regulatory complexities and bureaucracy.

What is EPFO and How Does it Benefit Workers?

The Employee’s Provident Fund Organisation (EPFO) is a government body in India that manages a savings scheme for salaried workers.

• The EPF scheme is like a long-term savings plan, where both employees and employers contribute a small portion of their salary every month.
• This amount accumulates over time and can be withdrawn at retirement or during emergencies.

The benefits of EPFO are manifold, providing crucial support and security to employees throughout their careers and into retirement.

• Firstly, EPFO ensures financial security by establishing a retirement fund that employees can rely on as they age, offering a significant support system in their later years.
• Additionally, insurance coverage is provided through life insurance benefits under schemes like the Employees’ Deposit Linked Insurance (EDLI), ensuring that members have a safety net in case of unforeseen events.
• Upon retirement, workers become eligible for a monthly pension, which delivers a steady income during their golden years, enhancing their financial stability.
• Moreover, EPFO offers flexibility with medical and emergency withdrawals, allowing members to withdraw funds for essential needs such as medical emergencies, educational expenses, or purchasing a home, thereby making it a highly versatile financial tool that adapts to various stages and demands of life.

In short, the EPFO acts like a safety net, ensuring that workers are better protected and have some financial stability.

Steps Taken in India for Formalization

• Digital Infrastructure:
  • Aadhaar: Unique identification system for financial inclusion.
  • Unified Payments Interface (UPI): Simplified digital transactions to integrate informal businesses.
  • Goods and Services Tax (GST): Unified tax structure to formalize the supply chain.
• Policy Measures:
  • Startup India: Simplified compliance for new businesses.
  • Pradhan Mantri Jan Dhan Yojana (PMJDY): Opening bank accounts for financial inclusion.
  • EPFO and E-SHRAM: Platforms for formalizing labour and social security benefits.
• Technology Adoption:
  • Digital tools like e-marketplaces and e-invoicing bring informal businesses into the formal framework.
• Skill Development and Awareness:
  • Government programs aimed at educating businesses and workers about the benefits of formalization.

How EPFO Registration Reflects Increased Formalization?

• When a worker registers with the EPFO, it means that they have a formal job where their employer is contributing to their social security.
• More EPFO registrations indicate that more jobs are moving into the formal sector, meaning more people are getting access to the benefits and security mentioned above.
• It’s a sign that the Indian economy is becoming more organized, with companies following regulations to support their employees better.

Significance of Workforce Formalization for India

• Economic Benefits:
  • Increased Tax Revenues: Formal employment ensures compliance with income tax and GST, increasing government revenues for developmental projects.
  • Productivity Growth: Formal workers often have access to better training, tools, and technologies, enhancing overall productivity.
  • Improved Data Collection: A formal workforce allows for accurate employment statistics, aiding evidence-based policymaking.
• Social Benefits:
  • Social Security and Benefits: Formal workers gain access to pensions, healthcare, maternity benefits, and insurance schemes like EPFO and ESIC.
  • Reduction in Vulnerability: Formalization reduces workers’ exploitation, ensures minimum wages, and improves working conditions.
  • Gender Equity: Formal jobs can lead to better inclusion of women in the workforce with provisions for maternity leave and anti-discrimination laws.
• Business and Market Dynamics:
  • Access to Credit and Capital: Formal businesses and workers have better access to credit, encouraging entrepreneurship and economic activity.
  • Market Expansion: Formalization enables businesses to scale operations, attracting investments and integrating into global value chains.
• Governance and Policy Impacts:
  • Enhanced Compliance: Formalization ensures compliance with labor laws, reducing workplace conflicts.
  • Targeted Welfare Delivery: A formal workforce makes it easier to deliver targeted welfare benefits through Aadhaar-linked direct benefit transfers.

Challenges in Workforce Formalization

• High Informality Levels: Around 90% of India’s workforce is informal, presenting a massive challenge for formalization.
• Employer Reluctance: Many employers prefer informal contracts to avoid regulatory compliance and costs.
• Worker Hesitation: Informal workers may resist formalization due to fear of reduced take-home pay (due to deductions for social security contributions).
• Inadequate Enforcement: Weak enforcement of labour laws exacerbates informality, especially in rural and semi-urban areas.

Conclusion

The journey of formalization of the Indian economy is a positive one. By increasing formal job registrations, India is building a stronger, more resilient workforce. It means that even during tough times, like the COVID-19 pandemic, there is a safety net to protect families.

The formalization of the economy is a gradual but essential process for sustainable development. By addressing barriers like complex regulations and lack of awareness, governments can accelerate this transition. Enhanced formalization not only benefits individuals and businesses but also strengthens the overall economic framework.

• Countries like Brazil and South Africa have implemented programs to encourage informal workers to register and access social security.
• Simplified tax regimes and reduced compliance costs have proven effective in several developing economies.

Frequently Asked Questions (FAQs)

What is the structure of the Indian economy?

Ans: There are three sectors in the Indian economy, they are; primary economy, secondary economy, and tertiary economy. In terms of operations, the Indian economy is divided into organized and unorganized. While for ownership, it is divided into the public sector and the private sector.

Related articles:

• Indian Economy: growth, development and employment
• Indian economy and Issues relating to planning, mobilization of resources, growth, development and employment
• Indian Economy 2023: Predictions and Challenges

-Article by Swathi Satish