What is the informal sector? Explain its formation and its persistence despite substantial economic change in cities in late industrializing countries. What would formalizing the informal sector mean in practice? What might be the role of the state? Provide evidence where formalization has/has not worked and offer some reasons why that was case.

Introduction

The informal sector in majority of the developing countries represent approximately 50% of the entire economic activity. It sustains and provides livelihood to a large majority of people, notwithstanding that, the part it plays in overall economic development remains contentious (Porta and Shleifer, 2014). It is observed that although this sector is widespread in the developing countries, it has relatively low productivity compared to the formal sector, mostly concentrated with poor and less educated entrepreneurs and is largely disconnected from the formal sector. The reason why many entrepreneurs tend to set up small scale firms in the informal sector is the avoidance of taxes and regulations and because they are aware that the productivity of their firms are quite low and would not allow them to thrive in the formal sector (Porta and Shleifer, 2014).

According to Peterson (2013), a cursory glance at the informal sector reveals that it is not problematic at all in the short run, as it tends to be the primary source of livelihood and sustenance for the poor. However, in the long run it has an adverse effect on a country’s economy and can stagnate the government’s social programs. If informal sector growth remains uncontrolled, this mean an economy that is beyond the control of the government or regulatory agency would not be able to provide the necessary protection to the workers and workers will continue to have lower standards of living compared to their counterparts in the formal sector. The reasons the workers in the informal sector continue to have low living standards are irregularity in their working days, absence or lack of minimum wage, lack of health and safety facilities, inability to enforce the contractual arrangements and absence of social protection (Peterson, 2013).

In this paper, I argue that despite the fact that the informal sector provides means of sustenance for the poor and relatively less educated it has numerous disadvantages and steps should be taken by the state towards formalization of the sector. The paper looks at the informal sector in Pakistan and why inequality persists in the opportunities for the workers in this sector. The informal sector’s growth should be curtailed in the developing countries because 1) informal sector workers have very low level of protection from the police and judiciary in case of crimes committed against their property 2) as most of the informal sector workers do not possess the capacity to enter into binding contracts, this prevents them from accessing capital markets for the purposes pertaining to finance and insurance and they are also not able to fully make use of social welfare, skill enhancement training programs and other government/public incentives (Loayza, 1999).

In this paper, I will begin with first explaining what the informal sector entails and what are its key characteristics. I will go on to discuss the emergence and persistence of this sector focusing primarily on two issues that in my view have contributed to this sector i.e. globalization/trade liberalization and poverty. I will look at the informal sectors in Pakistan and India to some extent as my case studies to explain what formalization of the informal sector means and what could be role of the state in that regard. The conclusion will reiterate that although informal sector is not entirely unfavourable for the poor, it could have negative impact on the economy in the long run.

The informal sector: what is it?

There is no definitive and conclusive single definitio