Economic reforms have not reduced dualism in Indian manufacturing-A modern one n d the informal sector/5 Jan, 2012

5 Jan, 2012, 05.09AM IST, Kunal Sen,

Economic reforms have not reduced dualism in Indian manufacturing

Mordern one and the informal sector !!



Indian manufacturing has two very different segments. A modern one, where production occurs in factories with moderate to high levels of technology, and under generally wellregulated conditions for workers, who are relatively well paid, have strong protection against dismissal in the courts, and who often have other benefits such as gratuity and paid leave. In economics parlance, we call this segment the formal sector.

Then there is the informal sector, where production often takes place in small sweatshop-type conditions , where there is very little use of modern technology , where workers can be fired at will, are paid badly and have almost no benefits. Unfortunately, in India, the majority of firms and workers are in the informal sector , leaving only a small section of firms and workers in the formal sector.

Estimates vary on the size of the informal sector, but a recent official report puts the proportion of workers employed in manufacturing in the informal sector at 80%. Even by developing country standards , India's manufacturing sector is highly dualistic. India's high level of dualism is bad both from the point of view of efficiency and equity. A large presence of the informal sector implies that overall productivity is lower than what may have been if the informal sector were smaller, given the low productivity in the informal sector as compared to the formal sector.

At the same time, large differences in earnings between workers in the informal and formal sectors contribute to a high level of income inequality in the country, and the lack of skills and education in workers in the informal sector constrains their ability to move to the better-paid jobs in the formal sector.

It has been often argued that the major reason behind the prevalence of dualism in Indian manufacturing has the policy regime in the past, and that the Licence Raj along with restrictive trade policies pursued by the Indian government till 1991 contributed to the dualism structure of the manufacturing sector, as these policies have been protective of the formal sector and constrained the growth of the informal sector.

An oft-repeated view, particularly originating from the World Bank, is that economic reforms that allow for a level playing field between the informal and formal sectors can reduce dualism significantly . Given that significant economic reforms have occurred in India since 1991, has this happened? The answer is in the negative.

While average efficiency levels in both the informal and the formal manufacturing sectors have increased in industries that witnessed the most reforms, economic reforms have increased the difference in average efficiency between the more efficient formal firms and the less efficient informal firms in Indian manufacturing. Economic reforms have also increased the gap between the most efficient firm in an industry and the average firm in that industry, and this widening of the efficiency gap has happened more in the formal sector.

Economic reforms have, thus, increased dualism in manufacturing , both by increasing the difference in efficiency between formal and informal firms and by increasing the efficiency gap between the most efficient firm and the average firm in both the formal and informal sectors. Surprisingly, even the withdrawal of reservation policies of the small-scale sector , a set of reforms that many believed would allow informal firms to catch up with formal firms, has in fact had the opposite effect, exacerbating the differences in productivity between informal and formal firms.