The Future of Informal Sector in India’s Formalising Economy

🌟 Key Takeaways: The Future of Informal Sector in India’s Formalising Economy

Nearly 85% of India’s workforce is still in informal jobs, contributing about half of GDP.
GST, digitalisation, and new labour codes are gradually pulling workers and firms into the formal net.
The gig economy is reshaping informality — workers are digitally visible but still lack protections.
Regional divide: Southern and Western States are ahead, while Northern and Eastern States remain largely informal.
By 2040, informal employment may decline to 60–65%, but hybrid models (semi-formal, gig) will dominate.
The challenge: Make formalisation inclusive — simplify compliance, expand social security, and support MSMEs.

📌 Bottom Line: India’s informal sector will not disappear but evolve. The goal should be transformation with dignity — ensuring growth, productivity, and protection for millions of workers.

Introduction

India is one of the fastest-growing economies in the world, but it also has one of the largest informal sectors. This means that a majority of businesses and workers operate outside the formal system of registration, taxation, and regulation. They may not have contracts, social security, or access to formal credit, yet they keep the economy running. For decades, the informal sector has been the backbone of livelihoods for millions of Indians, especially the poor and migrants.

As India moves towards greater formalisation through digital technology, regulatory reforms, and government policies, the informal sector faces both opportunities and challenges. The road ahead will shape not only the future of employment in India but also its economic and social stability.

This article explores the evolution, size, role, challenges, and future of the informal sector in India’s formalising economy, with comparisons to other countries and practical policy insights.

Historical Context: How the Informal Sector Grew

After independence in 1947, India’s formal sector was relatively small. Heavy industries, government enterprises, and a few private companies created limited formal jobs. At the same time, population growth and rural poverty pushed millions into agriculture, self-employment, and casual labour.

Through the 1960s–1980s, economic restrictions, licensing, and weak infrastructure made it difficult for small businesses to join the formal system. Informal employment flourished because it required little paperwork or compliance.

Liberalisation in 1991 opened India’s economy, but formal job creation did not keep pace with population growth. Millions of new entrants into the labour market—especially rural migrants—found work only in construction, domestic services, street vending, or small workshops.

Thus, the informal sector became the default employer of India’s growing workforce. Even today, while the economy is modernising, the majority of workers remain in informal jobs.

Current Size and Profile of India’s Informal Sector

The informal sector is massive in India:

Workforce share: About 75–80% of India’s workforce (roughly 380–400 million people).
GDP share: Contributes nearly 45% of India’s GDP.
Rural dominance: Agriculture and allied activities remain largely informal, employing over 200 million workers.
Urban presence: Street vendors, daily wage construction workers, gig workers, and small-scale manufacturers.

Who Works in the Informal Sector?

Self-employed workers – Small shopkeepers, hawkers, drivers, tailors.
Casual labourers – Construction workers, domestic workers, agricultural labourers.
Small-scale entrepreneurs – Home-based garment workers, repair shops, artisans.
Women workers – Many women are engaged in home-based or unpaid family work.
Migrant workers – Seasonal migrants fill gaps in urban labour demand, but with little protection.

This sector provides livelihoods but with low wages, insecurity, and lack of social protection.

Why the Informal Economy is So Large

Several reasons explain why informality dominates India:

Ease of entry – It is easy to start an informal business without legal hurdles.
Cost of compliance – Taxes, licenses, and audits are expensive for small businesses.
Limited formal jobs – India adds millions of new workers every year, but formal industries cannot absorb them all.
Cultural preference for cash – Many Indians prefer cash transactions, which remain outside the tax net.
Weak enforcement – Regulations exist but monitoring small, scattered enterprises is difficult.

The result: informality has been a survival strategy rather than a choice.

The Push Towards Formalisation

Over the past decade, India has taken strong steps to bring informal workers and enterprises into the formal system:

1. Digital Technology

Aadhaar: Biometric ID to track individuals.
Jan Dhan Yojana: Bank accounts for the unbanked.
UPI: Digital payments system widely used by street vendors and small shops.
Together, these create a digital footprint that enables access to credit and government schemes.

2. Goods and Services Tax (GST)

GST replaced multiple state and central taxes. Businesses above a turnover threshold must register and file returns, pushing many small firms to formalise.

3. Labour Codes

Four new labour codes simplify 29 existing labour laws. They set uniform rules for wages, benefits, and working conditions, making it easier to regulate small firms and extend protections to more workers.

4. MSME Registration

Micro, Small and Medium Enterprises can now register online under the Udyam system, gaining access to loans, subsidies, and government procurement opportunities.

5. E-Shram Portal

A national database of unorganised workers was launched in 2021. Over 300 million workers have registered, giving the government a tool to provide social security benefits.

These reforms are slowly formalising India’s economy—but the process is uneven.

Regional Differences in Informal Employment

The informal sector varies across regions:

North & East India (Bihar, Uttar Pradesh, Jharkhand, Odisha): Heavy dependence on agriculture and construction. Informality is extremely high, with limited social security coverage.
West India (Maharashtra, Gujarat, Rajasthan): Informal workers often linked to manufacturing and trade. More productive, but still vulnerable.
South India (Tamil Nadu, Karnataka, Kerala): Higher literacy, better industrialisation, and stronger welfare systems have led to greater formalisation. For example, Kerala has social security boards for informal workers.

These differences mean regional strategies are necessary rather than a uniform national approach.

Case Studies

1. Street Vendors and Digital Payments

In cities like Delhi and Bengaluru, street vendors increasingly accept UPI payments. This creates transaction records, enabling them to apply for loans under PM SVANidhi scheme. Many vendors who were invisible to banks now access credit and insurance.

2. Gig Workers

Platforms like Swiggy, Zomato, Ola, Uber employ millions of gig workers. Though technically independent contractors, these workers are registered, paid digitally, and sometimes insured—placing them in a semi-formal space.

3. Kerala’s Welfare Boards

Kerala has set up welfare boards for construction workers, autorickshaw drivers, and domestic workers. Registered workers contribute a small fee, and the government provides pensions, insurance, and healthcare. This model shows how informal workers can be integrated into welfare systems.

Challenges in Transition

Job losses – Small firms unable to comply with formal rules may shut down, displacing workers.
Compliance burden – For very small businesses, paperwork and digital filing are still difficult.
Exclusion risk – Many workers may be registered but not actually benefit from schemes.
Regional inequality – Southern states may formalise faster, leaving poorer states behind.
Gender gap – Women in home-based or unpaid work may remain outside formal systems.

Opportunities for the Future

Digital Credit – With UPI records, small businesses can get loans more easily.
Women’s Empowerment – Formalisation of home-based workers and self-help groups can give women financial independence.
Gig Economy Growth – Gig platforms could provide social security through partnerships with government.
Export Competitiveness – A stronger formal sector with documented supply chains will help India attract global buyers and investors.

Global Comparisons

China: Aggressively formalised small enterprises through industrial clusters and social security reforms. But still maintains a large rural informal workforce.
Brazil: Created simplified tax and registration systems for micro-entrepreneurs (Simples Nacional). This increased formalisation among small businesses.
Indonesia: Large informal workforce but recent reforms focus on job creation through labour code simplification.
Developed countries: Informal work is small, usually restricted to part-time or undocumented migrant jobs, due to strong social security and compliance enforcement.

India can learn from these examples: simplified compliance, strong social protection, and regional tailoring of policies.

Future Outlook: 10–20 Years

The informal sector will not vanish soon. But by 2040, it will likely shrink from 80% of employment today to around 50–55%.

Agriculture will reduce as more workers shift to services and industry.
Digital technology will make small enterprises semi-formal.
Social security coverage will expand through E-Shram and similar schemes.
Women and youth may benefit most from new opportunities if supported by policy.

The key is to ensure inclusiveness—so that workers are not pushed out of livelihoods during formalisation.

Policy Recommendations

Simplify compliance further – One-page tax returns, mobile-based reporting for micro enterprises.
Strengthen social security delivery – Ensure registered workers actually receive pensions, insurance, maternity benefits.
Regional focus – Prioritise Eastern and Northern states where informality is highest.
Public–private partnerships – Work with gig platforms, cooperatives, and NGOs to bring workers into welfare nets.
Skill development – Train informal workers to move into higher-paying formal jobs.
Gender-sensitive policies – Recognise and support women’s unpaid and home-based work.

Conclusion

The informal sector is India’s hidden strength and weakness. It provides livelihoods but with insecurity. Formalisation is necessary for India to grow into a truly modern economy, but it must be gradual, inclusive, and region-sensitive. With digital innovation, government support, and cooperative models, India can ensure that the informal sector’s future is not about disappearance but about transformation into a secure, productive, semi-formal economy.

Glossary

Informal sector – Work without registration, contracts, or social security.
Formal sector – Registered businesses and jobs with legal protections.
MSME – Micro, Small and Medium Enterprises.
GST – Goods and Services Tax.
UPI – Unified Payments Interface, India’s instant digital payment system.
Gig economy – Digital platforms offering short-term jobs or contracts.
E-Shram portal – National database of unorganised workers.

References

International Labour Organization (ILO) reports on informality in India.
NITI Aayog studies on gig and platform workers.
NSSO (National Sample Survey Office) data on employment.
World Bank (2021). “Informal Economy and Digital Inclusion in India.”
Ministry of Labour & Employment, Government of India.
RBI and Economic Survey of India (various years).

📌 Policy Brief – Key Insights & Recommendations

1. Current Reality

75–80% of India’s workforce (≈ 400 million people) is in the informal sector.
Contributes ~45% of GDP.
Dominated by agriculture, construction, street vendors, gig workers.
Informality is highest in North & East India, lowest in Southern states.

2. Why Informality is So Large

Limited formal jobs.
High cost & complexity of compliance.
Cultural preference for cash.
Weak regulatory enforcement.
Easy entry into informal activities.

3. Transition Drivers

Digital identity & finance (Aadhaar, Jan Dhan, UPI).
Tax reforms (GST).
MSME registration (Udyam portal).
E-Shram portal – 300M+ workers registered.
New Labour Codes.

4. Opportunities

Digital credit access for street vendors & small traders.
Women empowerment via SHGs & home-based work formalisation.
Gig economy as bridge between informal & formal.
Global competitiveness through documented supply chains.

5. Challenges

Risk of job losses in micro-enterprises.
Compliance burden for small firms.
Social security delivery gaps.
Uneven regional pace of formalisation.
Gender gap in access to benefits.

6. Global Lessons

China – Industrial clusters & social protection.
Brazil – Simplified micro-tax system.
Indonesia – Labour reforms, but informality persists.
Developed nations – Small informal sector (<15%) due to strong systems.

7. Future Outlook (2035–2040)

Informal workforce share may fall from 80% → 55%.
Growth of semi-formal gig economy.
Broader social protection coverage.

8. Policy Recommendations

✅ Simplify compliance (one-page returns, mobile-based reporting).
✅ Strengthen delivery of social security (pensions, insurance).
✅ Regional focus on North & East India.
✅ Public–private partnerships with gig platforms.
✅ Skill development for upward mobility.
✅ Gender-sensitive measures for women workers.

🎯 Takeaway

The informal sector will not vanish in India—it will transform. With inclusive policies, digital innovation, and strong welfare delivery, India can ensure its informal workers move into a secure, semi-formal economy, strengthening livelihoods and boosting long-term growth.

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