FORMAL SECTOR

INTRODUCTION :-
Forms have existed for a significant amount of time, with historians of law having
discovered preprinted legal forms from the early 19th century that greatly simplified
the task of drafting complaints and various other legal pleadings. It is believed that
the form was conceived by mathematician and inventor Charles Babbage. In some
jurisdictions, like California, many common types of legal pleadings must be
submitted on official government forms.

It is well known that a major part of the workforce in India and other developing
countries work in informal sector. Informal sector has become an increasingly
popular subject of study, not just in economics, but also in sociology and
anthropology. Keith Hart was the first person to introduce the term Informal Sector .
He introduced it while making a presentation on Informal income opportunities and
urban employment in Ghana in Institute of Development Studies (IDS) in September
1971 at a conference co-organized by Rita Cruise O Brien and Richard Jolly on
urban employment in Africa months before International Labour Organisation (ILO)
employment mission to Kenya came with its report Employment Incomes and
Equality (jolly, 2006). Hart distinguished formal and informal (both legitimate and
illegitimate) income opportunities on the basis of whether the activity entailed wage
or self-employment (Hart, 1973)

.Therefore the concept of informal sector used by Hart was limited to small self-
employed individual workers. Although Harts concept of informal sector had some
limitations, the introduction of this concept made it possible to incorporate activities
that were previously ignored in theoretical models of development and in national
economic accounts ( 1991). The term informal sector came in a broader sense in the
academic literature only after the visit of an International Labour Organization (ILO)
employment mission to Kenya in 1972.

The ILO then evolved a conceptual framework and guidelines for the collection of
statistics on informal sector and presented the same in the Fifteenth International
Conference of Labour Statisticians (ICLS) held in February, 1993 in the form of a
resolution. The resolution was then endorsed by the United Nations Statistical
Commission (UNSC) and made a part of the System of National Account (SNA)
1993 by the United Nations Economic and Social Council.

Though the term informal sector gained currency after ILO evolved a conceptual
framework and guidelines for the collection of statistics on informal sector, there has
not been any single definition of informal/unorganised sector in India. Informal sector
is a matter of discussion among the academics, policy makers etc. from the
beginning as a large chunk of workforce employed in this sector. Different criteria are

Page 1
used to identify the informal sector but non of them was universally applicable in
different empirical situations (papola, 1981).

A study by Mitra (2001) based on fourth economic census of India took the criteria of
own account enterprises and employment establishments employing one to nine
workers to identify the informal sector. The different organizations of India like
National Sample Survey Organization (NSSO), Directorate General of Employment
and Training (DGET) etc used varying definitions of informal/unorganized sector
depending on the specific requirements of each organization.

Keeping in view the absence of a uniform definition of informal/unorganized sector

in India the National Commission for Enterprises in the Unorganized Sector
(NCEUS) set-up a Task Force to review the existing definitions Ph.D. Scholar in
Jawaharlal Nehru University, New Delhi, India.

Former Consultant in the National Commission for Enterprises in the Unorganized

Sector (NCEUS). 2 and formulated harmonized definitions of informal/unorganized
sector employment and informal/unorganized employment.

Page 46
SOURCE :
The study is based on secondary data collected by the National Sample Survey
Organisation (NSSO) for 1999-2000 and 2004-05 through quinquennial surveys on
Employment- Unemployment.

Existing Definitions of Informal Sector International Definition As per SNA (1993),

the informal sector consists of units engaged in the production of goods or services
with the primary objective of generating employment and income to the persons
concerned.

These units typically operate at a low level of organization, with little or no division
between labour and capital as factors of production and on a small scale. Labour
relations - where they exist - are based mostly on casual employment, kinship or
personal and social relations rather than contractual arrangements with formal
guarantees.

The informal sector forms part of the household sector as household enterprises or,
equivalently, unincorporated enterprises owned by households. Definitions used in
India

The First Indian National Commission on Labour (1966-69) defined unorganised

sector workforce as those workers who have not been able to organize
themselves in pursuit of their common interest due to certain constraints like casual
nature of employment, ignorance and illiteracy, small and scattered size of
establishments.

The National Sample Survey Organization (NSSO), which has been conducting
surveys of un-organized enterprises at periodical intervals, generally adopted the
following criteria for the identification un-organized sector:

i. In the case of manufacturing industries, the enterprises not covered under the
Annual Survey of Industries (ASI) are taken to constitute the un-organized
sector. ii. In the case of service industries, all enterprises, except those run by
the Government (Central, State and Local Body) and in the corporate sector
were regarded as un-organized.
ii. The NSSO also conducted a separate informal sector survey in 1999-2000
and all non-agricultural enterprises, excluding those covered under the ASI,
with type of ownership as either proprietary or partnership were treated as
informal nonagricultural enterprises for the purpose of the survey.
iii. In the compilation of National Accounts, the term un-organized sector is used
to represent the residual enterprises, which are not included in the organized
sector.
iv. The coverage under organizational sector , however, differed across
different segments of the economy depending on regular data availability
from various administrative sources.

Page 46
RATES
financial intermediaries and financial markets Financial intermediaries have
traditionally been divided into different categories, according to specific
characteristics, as concerns their institutional setting, the range of intervention, their
organisation and services provided. Different bank classes can be found both in
industrialised economies and in developing countries; the distinction among
commercial banks, savings banks or development banks, for instance, is still very
common.

However, in some countries, this classification is becoming less significant,

particularly on the operational side, because the evolution of the regulatory
framework and the increasing competition led many banks to enlarge their fields of
intervention. In some countries the distinction is still applicable. Despite the process
of homogenisation of bank classes, an analysis of the typical goals and average
performance of different kinds of banks is still useful because current performances
are affected by past institutional and operational objectives and constraints and
because many countries are going now through a transitional phase where old bank
categories exist but their institutional function are loosing specificity.

Public authorities have often led the process of differentiating the functions of
various bank categories or non-bank financial intermediaries, through the legal
definition of the institutional function of each class of intermediary; yet the financial
intermediaries themselves often lead the process of specialisation, in accordance to
their goals and available resources.

This is typically the case for commercial banks, whose intervention in the
agricultural sector of developing countries is often minimal as a consequence of their
choice to limit their activity to other sectors of the economy. Political and economic
factors, as well as geographical and historical heritages affect the countries specific
banking structure; however, the approach commonly followed in organising the
formal financial system in many developing countries achieved similar results as
concerns the intermediaries performance. Therefore a common framework of
analysis can be found and generalisations on each bank category are possible. The
following paragraphs provide an overall description of bank categories, their
institutional roles, typical performance and effectiveness in servicing the customer
with an accent on their actual or potential activity in the agricultural sector. Before
entering this description, two important classifications are presented: the distinction
between bank and non-bank financial intermediaries and between formal and
informal financial markets.
On the first respect the following definitions are applicable: 1 By Laura Vigan,
Universit di Bergamo, Italy on behalf of Fondazione Giordano DellAmore.
PAGE 45
Agricultural Training Manual 3 Definition of bank A financial intermediary is defined
as a bank when it performs both savings mobilisation and lending Definition of a non-
bank financial intermediary If a financial intermediary is only active on one side of
the balance sheet (i.e. it offers deposits but does not lend out to the public, or it
offers loans but gets funding from sources other than private savings) it is classified
as a non-bank financial intermediary.

As concerns the formal and informal financial markets, the classification depends on
the degree of regulation exerted by the monetary authorities on the intermediaries.
Conventionally: THE INFORMAL FINANCIAL MARKET GROUPS ALL THE INTERMEDIARIES
THAT ARE NOT REGULATED BY THE MONETARY AUTHORITIES OR ANY OTHER PUBLIC
AUTHORITY AND WORK WITH A LOW DEGREE OF FORMALIZATION ON THEIR
TRANSACTIONS (Germidis et al.; Onado and Porteri).

The presence of an informal market should be given enough attention since it

affects the effectiveness of monetary policies; furthermore, its relative success in
reaching agricultural operators may lead monetary authorities and banks to re-
consider their approach to rural areas. In order to better understand institutional
goals and constraints of the formal markets and the potentialities of the informal
market, an introduction on the typical monetary authorities interventions follows
hereafter; it is further developed during the presentation of each class of
intermediaries; a classification of the operators of the informal financial market will be
presented in Part III of this manual. 3.2 Public Power of Monetary

Authorities in the Formal Market and the Agricultural Sector Monetary authorities
have the specific role to control the financial system and to address its development
according to some objectives in line with the general economic policy of the country.

Generally speaking, this means getting continuously up-dated information on the

operation of each intermediaries in order to: Agricultural Training Manual 4 verify
the level of financial aggregates such as money in circulation and credit and take
appropriate measures to influence their trends control the soundness of each
institution and assure a certain level of stability of the financial system promote
efficiency in the financial market implement public economic policies through ad
hoc interventions. The various objectives and possibilities of intervention of monetary
authorities have already been presented in the first part of this manual. Particular
measures that are typically implemented in order to develop the agricultural sector
are the following:

the imposition of credit ceilings on non-priority sectors and floors on the agricultural
one to assure a minimum flow of resources towards agriculture;

special rediscount rates at which banks can have access to public funding if they
invest in the agricultural sector;

the imposition of concessionary interest rates on loans to agricultural operators;

Page 46
 the implementation of public agricultural credit programmers for target
beneficiaries through public or private banks;

the creation of ad hoc intermediaries to implement specific financial development

programmes for agriculture. These measures can concern the whole system, i.e.
private or public banks or non-bank intermediaries, but are usually more easily
implemented through public banks, on which monetary authorities have a more
effective control.

The effectiveness of these measures in reaching their purpose of promoting

agricultural development have been questioned by policy makers, academicians and
practitioners; the reasons for these criticisms are presented in section 4, while
examining agricultural development banks which usually undergo these public
interventions with questionable results.

Besides the possible weaknesses to the interventionist approach, a more general

consideration can be made: PUBLIC INTERVENTIONS IN FINANCIAL MARKETS
ARE EFFECTIVE ONLY IF MONETARY AUTHORITIES CAN ACTUALLY MONITOR
FINANCIAL INTERMEDIARIES, WITH APPROPRIATE INSTRUMENTS,
TECHNOLOGIES AND PERSONNEL.

This is not always the case in many developing countries where, furthermore, an
important share of the market is covered by informal intermediaries whose existence
is (or was) often officially ignored by public powers. Agricultural Training Manual 5

The Formal Financial Market and Agricultural Credit FORMAL FINANCIAL

MARKETS GROUP THE INTERMEDIARIES THAT ARE RECOGNIZED BY THE
GOVERNMENT AND, THEN, ACT UNDER THE MONETARY AUTHORITIES
SUPERVISION OR ARE AT LEAST CONNECTED WITH SOME PUBLIC
FUNCTION.

Typical operators in these markets are: commercial banks, savings banks,

official co-operative banks or credit unions, development banks, other non-bank
financial intermediaries as insurance or leasing companies

The latter group of intermediaries has practically no relations with the agricultural
sector; even within the bank categories, the agricultural sector can represent a
marginal activity for some of them while for others it is the major focus of
intervention.

. COMMERCIAL BANKS In almost every country operate one or some commercial

banks. Generally speaking, typical operations of commercial banks are the collection
of savings from private and public depositors and lending to the private and public
sectors. In developing countries they typically have the following characteristics:
PAGE 45
 Commercial banks operate the most with the private sector, particularly for what
concerns lending.

Commercial banks generally concentrate their activity on offering financial services

to the more dynamic sectors of the economy, often linked to foreign capital.

Their capital can be divided among private and public owners or they can be fully
private or controlled by the government. When they are performing, they usually
attract foreign capital; in some countries, branches of foreign commercial banks
operate.

Commercial banks usually operate according to advanced managing principles and

standards, typical of industrialised economies, particularly when they are
privatelyowned.

Public commercial banks operations are sometimes led by governmental

directions, which can be different from banking managerial principles and may lead
banks to pursue social rather than economic objectives. Agricultural Training Manual
6

Page 46
 INFORMAL
INTRODUCTION
It is well known that a major part of the workforce in India and other developing
countries work in informal sector. Informal sector has become an increasingly
popular subject of study, not just in economics, but also in sociology and
anthropology. Keith Hart was the first person to introduce the term Informal Sector .
He introduced it while making a presentation on Informal income opportunities and
urban employment in Ghana in Institute of Development Studies (IDS) in September
1971 at a conference co-organized by Rita Cruise O Brien and Richard Jolly on
urban employment in Africa months before International Labour Organisation (ILO)
employment mission to Kenya came with its report Employment Incomes and
Equality (jolly, 2006).

Hart distinguished formal and informal (both legitimate and illegitimate) income
opportunities on the basis of whether the activity entailed wage or self-employment
(Hart, 1973).Therefore the concept of informal sector used by Hart was limited to
small self-employed individual workers. Although Hart s concept of informal sector
had some limitations, the introduction of this concept made it possible to incorporate
activities that were previously ignored in theoretical models of development and in
national economic accounts (Swaminathan, 1991).

The term informal sector came in a broader sense in the academic literature only
after the visit of an International Labour Organization (ILO) employment mission to
Kenya in 1972. The ILO then evolved a conceptual framework and guidelines for the
collection of statistics on informal sector and presented the same in the Fifteenth
International Conference of Labour Statisticians (ICLS) held in February, 1993 in the
form of a resolution. The resolution was then endorsed by the United Nations
Statistical Commission (UNSC) and made a part of the System of National Account
(SNA) 1993 by the United Nations Economic and Social Council.

Though the term informal sector gained currency after ILO evolved a conceptual
framework and guidelines for the collection of statistics on informal sector, there has
not been any single definition of informal/unorganised sector in India. Informal sector
is a matter of discussion among the academics, policy makers etc. from the
PAGE 45
beginning as a large chunk of workforce employed in this sector. Different criteria are
used to identify the informal sector but non of them was universally applicable in
different empirical situations (papola, 1981).

A study by Mitra (2001) based on fourth economic census of India took the criteria of
own account enterprises and employment establishments employing one to nine
workers to identify the informal sector. The different organizations of India like
National Sample Survey Organisation (NSSO), Directorate General of Employment
and Training (DGET) etc used varying definitions of informal/unorganised sector
depending on the specific requirements of each organisation.

SOURCE
The study is based on secondary data collected by the National Sample Survey
Organisation (NSSO) for 1999-2000 and 2004-05 through quinquennial surveys on
Employment- Unemployment. Existing Definitions of Informal Sector International
Definition As per SNA (1993), the informal sector consists of units engaged in the
production of goods or services with the primary objective of generating employment
and income to the persons concerned. These units typically operate at a low level of
organization, with little or no division between labour and capital as factors of
production and on a small scale. Labour relations - where they exist - are based
mostly on casual employment, kinship or personal and social relations rather than
contractual arrangements with formal guarantees.

The informal sector forms part of the household sector as household enterprises or,
equivalently, unincorporated enterprises owned by households. Definitions used in
India The First Indian National Commission on Labour (1966-69) defined
unorganised sector workforce as those workers who have not been able to
organize themselves in pursuit of their common interest due to certain constraints
like casual nature of employment, ignorance and illiteracy, small and scattered size
of establishments. The National Sample Survey Organization (NSSO), which has
been conducting surveys of un-organized enterprises at periodical intervals,
generally adopted the following criteria for the identification un-organized sector:

i. In the case of manufacturing industries, the enterprises not covered under the
Annual Survey of Industries (ASI) are taken to constitute the un-organized
sector.
ii. ii. In the case of service industries, all enterprises, except those run by the
Government (Central, State and Local Body) and in the corporate sector were
regarded as un-organized. The NSSO also conducted a separate informal
sector survey in 1999-2000 and all non-agricultural enterprises, excluding
those covered under the ASI, with type of ownership as either proprietary or
partnership were treated as informal nonagricultural enterprises for the
purpose of the survey. In the compilation of National Accounts, the term un-

Page 46
 organized sector is used to represent the residual enterprises, which are not
included in the organized sector.
iii. The coverage under organizational sector , however, differed across
different segments of the economy depending on regular data availability
from various administrative sources. The Directorate General of Employment
and Training (DGET) considers all establishments employing ten workers or
more as organized sector, though Employment Exchange (Compulsory
Notification of Vacancies) Act, 1959, makes it mandatory to submit
employment returns only for those units ordinarily employing twenty five or
more persons.

Challenges to implementation of social security:

1. of the workforce most of these are implementable but for contract Workers are

dispersed across fields difficult to find and organize

2. Workers are illiterate and lack awareness of their industry

After de-regulation we find that, capital has become more mobile and least

regulated, while labour is less mobile. Greater ease of mobility gives greater

bargaining power to capital (Bardhan: 2001). Thus, there is a need to define a

system where in labour and capital can co-exist peacefully.

The employers' demands for labour reforms include weaken union power, outlaw

strikes, individualize labour relations, privatize public enterprises, rationalize and

simplify labour laws, freedom to hire and fire and close undertakings, freedom to hire

contract labour, liberalize labour inspection system, freedom to introduce

PAGE 45
technological changes, repeal of legal provisions relating to bonus and so on. These

demands necessitate a radical shift from the state intervention model in IRS followed

in the regulation era.

On the other hand, the employees demands are of higher salaries, health coverage

and social security benefits. For organized sectorworkforce there are suggestions to

amend the Contract Labour Act of 1971 to include all these three. But, if these

amendments are to be passed; firms would employ less of labour and increasingly

substitute capital for labour.

With the interplay of economic, political and institutional forces in the new economic

environment, new issues, dilemmas, concerns and strategies have been thrown up

and the employment relations have become complex.

The market logic demands that the state's policies should aid in enhancing

competitiveness of firms and attract and retain capital (which uses the threat of re-

location). While it is certain that policies need to change, how and in which direction

it will change depends on political economy considerations.

While product market and capital market reforms go unnoticed by large number of

people concerned, labour reforms belong to 'mass politics' (Varshney 1999). Radical

labour reforms invite the wrath of the working class and have political costs. Further,

the state is under pressure to not effect labour reforms concerning the organised

sector and at the same time design policies to ensure welfare of millions of workers

in the informal economy, though fiscal prudence considerations restrain radical

welfare schemes. The strategy of the state is thus shaped by such complex forces.

Legislation for Informal Sector:

Page 46
There is some legislation that covers informal workers including the Minimum wages

act 1948, Equal remuneration act 1976, and The Maternity benefit act 1961. The

implementation of these existing laws is notoriously patchy and mostly non-existent

for informal workers.

In 2008, Unorganized Workers social security bill was passed to extend a universal

system of social security to all its members but low economic status of many workers

makes it difficult for the workers to access information about their entitlements and

service delivery.

COMPARISON
Formal and Informal Financial Sectors

INFORMAL FINANCIAL SECTOR FORMAL FINANCIAL SECTOR

1. The informal financial sector provides
savings and credit facilities for small
small-
farmers in rural areas, and for lower-
income households and small-scale
enterprises in urban areas.
1. Formal financial institutions ignore small
farmers, lower-income households, and
scale enterprises in favour of a larger-scale,
well-off, and literate clientele which can
satisfy their stringent loan conditions.

2. The procedures of informal schemes are 2. Complex administrative procedures are

beyond
usually simple and straightforward; as the understanding of the rural masses and
small
they emanate from local cultures and savers.
customs, they are easily understood by
the population.

3. The informal sector mobilises rural 3. Formal financial institutions do not mobilize
savings and small savings from low-income rural savings or small-scale deposits.
Commercial

PAGE 45
 urban househods. banks could contribute to rural and small
savings
mobilization if they had adequate branch
networks
and if they adopted the relevant procedures.

4. Informal groups operate at times and on 4. The working days and opening hours of formal
days which are convenient for their financial institutions do not take rural work
members. schedules into account;banks are oopen at times
when
farmers are at work in their feilds.

5. Informal sector associations accept any 5. Formal sector institutions are selective
regarding
amount of regular savings, even the most clientele, so as to avoid having clients who
make
modest sums which a saver can aford to set only small deposits. Their financial technology
is
aside. The financial techniques on which not suited to the management of modest sums
from a
such informal groups are based lend large number of savers.
themselves to the management of a large
number of small accounts.

6. Access to credit is simple, non- 6. Loan application procedures are complex and require
bureaucratic, and little based on reading and writing skills so that a file on the
writtern documents. Literacy is not borrower may be established.
a requisite.

7. The simple and direct processing of loan 7. Processing of loan requests is complex, resulting in
requests allows for their prompt approval long delays before final approval or rejection. Even
and a minimum delay in disbursement. when approval is obtained, loan delivery is slow.
Rejections are rare; but the level of
risk is reflected in the interest rate
charged.

8. Collateral requirements on loans are 8. Collateral requirements correspond to the situation of

to local conditions and borrowers relatively well-off urban-dwellers: deposits or
capacity. The conditions may be based savings accounts in a commercial bank, property
which
either on regular contributions to ROSCAs can be mortgaged.
or on precise knowledge of farm size and/or
crops harvested so as to determine the
borrower's capacity to repay a loan.

9. Transaction costs are low 9. Transaction costs are high

10. Repayment rates rates are high 10. Repayment rates are low.

11. Because they emanate from local 11. Formal sector institutions do not have close contact

Page 46
 environment, informal groups are aware
Sometimes
of the problems that members may be
confronted with, and therefore they
can deal with repayment difficulties
in a pragmatic manner. Debt rescheduling
is possible.
with the environment in whic they operate.
they prosecute defaulters, which can have negative
social repercussions, while at other times they do
not sue for reimbursement, leading borrowers to belive
that formal loans are free.

12. The informal sector has a dense and 12. Unfamiliar with the grass-roots environment, formal
effective information network at the institutions are ill-served by a mediocre supervisory
grassroots level for close supervision and monitoring network, and are unable to gain
insight
and monitoring of borrower activity - into the activities of their clientele.
particularly their cash flow - whether
they are members of an informal association
or not. This contributes to the efficient
mobilization of savings and ensures high
loan repayment rates.

13. Within the informal sector, information is 13. Formal sector institutions do not have a good
network
widely diffused. The regular meetings of for dissemination of information. In addition, they
are
informal savings and credit associations out of touch with the rural masses and make little
serve as a forum for dissemination of to seek ways of reaching them.
information.

14. The interest paid on deposits in the
informal sector compares favourably with
that paid in the formal sector, thus
providing an incentive fo rural and small
urban households to save.
14. Some institutions of the formal sector do not even
offer savings facilities. Others apply low - or
sometimes even negative - real interest rates, thus
putting off many a potential saver.

15. The informal sector charges competitive
lending rates; though they are sometimes
high, this reflects the scarcity of
nonetheless
loanable funds. There is little connection
between deposit and lending rates.
15. Public institutions charge very low - sometimes
negative - real interest rates on loans. Commercial
banks apply moderate lending rates which are
considerably higher than the interest paid on savings.
The link between deposit and lending rates is weak.

16. There are no investment opportunities 16. There are investment opportunities for savings
which
for savings which have been mobilized have been mobilized but which have not been lent.
but which have not been lent.

17. The informal sector usually does not 17. The formal sector keeps writtern records on the
keep a writtern record on the borrowing activities of clients, although the information
and/or saving activities of its clintele. recorded is sometimes irrelevant.
When it does, the procedures are
relatively simple.
PAGE 45
18. The volume and availability of loanable 18. The formal sector regularly has loanable funds
funds are subject to seasonal available.
fluctuations.

19. The informal sector is not subsidized 19. Formal sector institutions are subsidized by the
by the government, nor does it receive government and may also receive grants and other
grants or other forms of support from support from donor agencies.
donor agencies.

20. Savings and credit mechanisms in the
informal sector are not geared towards
accumulating funds befor ethe peak season
deprived
when loan requests are highest.
their loans.
20. A regular supply of funds allows the formal sector
to lend at any time of the year. This is not the case
with government lending institutions, which are
of sufficient funds because of high default rates on

21. Despite the widespread dissemination of 21. Formal sector institutions could reach a widely
information within the informal sector, dispersed rural clientele by collaborating with
informal groups are often unaware of new government extesion units. In practice, though,
farming methods, and so members do not they do not resort to such intermediaries and do
learn of new techniques which would allow not provide financial services in rural areas.
them to increase production leels and raise
their standard of living.

Page 46
 ISSUES OF FORMAL AND INFORMAL
Small-scale producers and enterprises have long been known to account for a large
share of economic activity in developing countries. Most of these enterprises are
noncorporate: small farmers, producers, tradespeople, and independent traders.
They do not maintain income statements and balance sheets, are not registered with
any government office, and often are not licensed as businesses. Recent studies
that have attempted to quantify their importance conclude that the noncorporate
sector accounts for 30-70 percent of the labor force in some developing countries.
Noncorporate businesses differ greatly in their demand for financial services. Street
vendors need short-term finance to buy stock, and they need a depository for
temporary surpluses. Small-scale producers need somewhat larger and longer-term
loans to buy equipment or to hire rionfamily labor.

Small farmers need to cope with an uncertain and fluctuating income stream, which
they do by accumulating liquid assets and sometimes rolling loans over to
subsequent cropping seasons. As farming becomes more capital-intensive, farmers
may also demand longer-term credit to buy equipment. This chapter examines the
ability of informal and formal institutions to satisfy the financial needs of households,
agriculture, and noncorporate enterprises. Formal financial arrangements are often
not well suited to the needs of the noncorporate sector.

The sums involved can be too small for a formal institution because many of the
costs of advancing a loan or accepting a deposit are independent of the size of the
PAGE 45
transaction. Often the cost to formal institutions of opening branches in villages and
small towns is not justified by the business that can be generated. In one African
country it was estimated that an institution serving a largely noncorporate clientele
would require a minimum of 2,500 deposit accounts to cover the cost of a single
employee for a year. Noncorporate borrowers rarely have collateral acceptable to
banks. Their creditworthiness resides in their human capital, which is difficult for
formal intermediaries to gauge. The interest rates that banks are allowed to pay for
deposits or to charge on loans often fail to reflect these factors.

All this makes supplying financial services to the informal sector unprofitable for
formal institutions. The popular view of informal finance is of powerful moneylenders
who exploit the poor through usurious interest and unfair seizure of collateral. In fact,
informal finance is both extensive and diverse.

The informal sector accounts for most of the financial services provided to the
noncorporate sector. In addition to family and friends, who provide a large
percentage of the loans, informal finance consists of professional moneylenders,
pawnbrokers, tradespeople, and associations of acquaintances. In separate studies
of five Asian countries, professional moneylenders provided less than 20 percent of
informal rural credit; on average they accounted for only 6 percent. Informal financial
arrangements reduce transaction costs and risk in ways denied to formal institutions.
Moneylenders, for example, can operate out of their own homes or on the street,
maintain only the simplest accounts, and mix finance with other business.

The services they provide are outside the review and control of the monetary
authorities. The remaining costs can be fully reflected in implicit or explicit interest
rates. Freedom from regulation allows informal agents greater flexibility. But it also
denies them many of the legal sanctions available to formal intermediaries. In place
of formal legal mechanisms, informal agents rely on their knowledge of one another
and on local sanction to reduce the risk of lending.

Social standing and the ability to obtain future financial services are often at stake in
the market for informal financial services. These sanctions are effective. That is why
informal financial arrangements are so widespread (see Box 8.1). Informal financial
arrangements Without trying to be exhaustive, this section offers examples of
informal financial arrangements.

The examples cover three main sorts of transactions: short-term finance for daily
stocks or emergencies; finance to smooth a fluctuating income stream; and finance
for larger, long-term investments. The limitations of informal arrangements are then
examined. Short-term credit Noncorporate enterprises commonly require small
amounts of short-term funds to cover immediate expenditures, such as a business
opportunity, a social obligation, or an emergency. Such funding might come from
moneylenders or pawnbrokers but is more likely to be borrowed from relatives or
friends. The choice of arrangement will depend on cost and convenience. But
informal short-term credit may entail hidden costs.

Page 46
For instance, lending between friends and relatives often carries low interest or no
explicit interest charge. In societies with strong traditions of mutual assistance and
reciprocity, individuals who need funds can call on friends and relatives for help.
Acceptance of such help obligates the borrower to reciprocate by providing
nonfinancial services or by supplying funds in turn when the lender needs to borrow.
These traditional obligations of mutual support can be a problem for those who wish
to accumulate capital

The desire to protect personal savings from family and friends creates a strong
demand for less accessible savings instruments when these become available.
Market vendors and other small businesses often turn to moneylenders for their
short-term credit needs. The so-called five-six arrangement under which the
borrower receives $5 in the morning and repays $6 to the lender in the evening is
common. The interest rate of 20 percent a day seems extremely usurious. But the
moneylender does not perform the transaction every day of the year, and p I I I L.
Box 8.1 Informal finance in Niger A sample of 398 village households in rural Niger in
1986 indicated that informal credit accounted for 84 percent of total loans and was
equal to 17 percent of agricultural income. Informal tontines (rotating savings and
credit associations), money guards, and merchant finance predominate.

The first two supply a variety of services in the local market, and merchant finance
bridges formal and informal markets. Large wholesalers borrow from formal banks,
purchase a range of consumer goods, and then consign these goods through a
network of small village retailers. These retailers, in turn, may sell the items to

PAGE 45
villagers on credit. Out of a sample of fifty-six tontines in twenty-two villages, some
had only four members, others more than forty.

The average member contribution ranged from 100 CFA francs (25 cents) to
CFAF25,000 ($70). The total size of all fifty-six tontines, as measured by member
contributions per meeting, was the equivalent of $72,000. This suggests a promising
base for deposit mobilization in rural Niger.

Many of the money guards are traders who have storage facilities, offer deposit and
pawnbroking services, and market goods in other regions. Fifty-six money guards
were surveyed in 1986 in the twentytwo villages in the tontine sample. Their deposit
base ranged from several depositors to as many as 150, and (in the immediate
postharvest season) from CFAFIO,000 ($30) to CFAF5 million ($13,000). They
neither paid interest on their deposits nor charged fees for safekeeping. Money
guards also provided loans, the average size of which was CFAF55,000 ($144). I I I ]
113 Box 8.2 Rotating savings and credit associations Rotating savings and credit
associations (ROSCAs) are a popular form of informal finance.

They have various aliases: tanda in Mexico, pasanaku in Bolivia, sun in the
Dominican Republic, syndicate in Belize, gumaiyah in Egypt, isusu in Nigeria, susu
in Ghana, tontine in Niger (see Box 8.1), hagbad in Somalia, xitique in Mozambique,
arisan in Indonesia, paluwagan in the Philippines, chit fund in India and Sri Lanka,
pia huey in Thailand, hui in China, kye in Korea, and ko in Japan. ROSCAs
intermediate in the most basic way. A small number of individuals, typically six to
forty, form a group and select a leader who periodically collects a given amount (a
share) from each member. The money collected (the fund) is then given in rotation to
each member of the group. In some countries, such as India and Cameroon,
ROSCAs have evolved into formal banks.

Three types of ROSCAs are found in many countries. In common ROSCAs, the
leader receives no special consideration (other than possibly getting the first fund).
Commission ROSCAs pay their leaders, who in return may assume liability for
defaults. Promotional ROSCAs are used by merchants to sell goods, especially
consumer durables. Loans are interest free in most common and promotional
ROSCAs; the amount received is equal to the total paid in by the member. More
sophisticated ROSCAs may allocate funds on the basis of discount bids, a practice
common in China, India, Thailand, and some parts of West Africa. The winner is the
person willing to accept the largest reduction in share payment from other
participants in return for receiving the next fund. All participants in a commission
ROSCA, except the leader, pay for the right to participate and receive back less than
they contribute.

Recent research in Bolivia showed that one-third to one-half of all adults living in
urban areas often participated in ROSCAs and that their ROSCA payments
amounted, on average, to about one-sixth of their salaries. These associations were
even found among employees of formal financial intermediaries. Despite

Page 46
hyperinflation and poor loan recovery by formal lenders, Bolivians reported few
problems in their ROSCAs. Studies show that a relatively high proportion of those
with steady incomes in Cameroon, India, and Sri Lanka often participate in ROSCAs.
These associations have also been reported among employees of the central banks
of Belize, Bolivia, the Dominican Republic, and the Philippines.

The popularity of ROSCAs among low- and middleincome groups shows that people
like to save, even under trying circumstances. The Bolivian research showed that
more than 90 percent of the people interviewed joined ROSCAs primarily because
they wanted to save more and felt that membership forced them to do so. I I j loan
losses and transaction costs reduce the realized rate of return.

To keep collection rates high and transaction costs low and to minimize the cost of
idle funds, the moneylender maintains relations with the same borrowers.
Conversely, borrowers are paying not only for that day's loan but also for continuing
access to immediate credit. Loans from moneylenders are typically shortterm and
are extended to clients of long standing; they are rarely tied to collateral. Most
moneylenders use their own funds for lending. Interest rates are high.

Where entry is restricted and alternative financial services are lacking, high interest
rates may be partly a result of imbalances in economic and social power, but the cost
and risk of small loans are also high. To meet the demand for timely and convenient
loans, the moneylender must maintain adequate liquidity, some of which will be idle
during slack periods.

The opportunity cost of this reserve is part of the moneylender's costs. Many
noncorporate agents with access to formal 114 credit may also borrow from
moneylenders if formal lenders take too long to process an application. Two to three
weeks is quick for many formal intermediaries, and two to three months is not
uncommon. Often, loans from moneylenders are used to make a transaction at short
notice, and funds from formal lenders are used to repay the moneylenders.
Borrowers who own marketable assets may turn to pawnbrokers for short-term
credit. Pawnbrokers take possession of assets for a fixed term and lend against
them at an agreed rate of interest.

During the term of the loan the borrower is free to repay and thereby to redeem his
asset. Once the term expires, the pawnbroker can sell the asset and keep the
proceeds. Because the loan has collateral, the pawnbroker needs no further
information about risk. But the pawnbroker must know the resale market well if he is
to sell such assets profitablyespecially since the borrower has the option of avoiding
the pawnbroker altogether by I I selling and then repurchasing the asset on his own.

PAGE 45
 Pawnbroking is an example of how collateral is used in some informal arrangements
to reduce risk and fill the gaps in information that characterize the noncorporate
sector. Other, slightly more sophisticated solutions include sale and repurchase
arrangements (in which the borrower retains physical possession of the asset while
the moneylender has legal title) and the use of overdraft checks for loan surety.

In these cases commercial law makes repayment enforceable, and recourse to

banking law continues to be avoided. Seasonal credit and short-term savings
Another common need is to smooth fluctuations in income. This can be done with
liquid savings or seasonal credit. In rural areas marketing intermediaries are often an
important source of credit for farmers. In urban areas retailers may offer credit for the
goods they sell. Marketing agents often provide lines of credit to farmers in return for
a commitment to sell produce through the agents. The farmer may be charged
explicit interest, or he may pay indirectly through the price received for his crop.

The agent knows the farmer, and this reduces his risk and transaction costs. It is
sometimes difficult for analysts to determine the implicit interest charges when loans
or repayments are made in kind. In the Sudan, for example, a merchant might
provide a farmer with two sacks of millet in return for three sacks at harvesttime two
months later. The apparent monthly interest rate is 25 percent.

But the true rate is much lower because the price of millet is typically higher between
harvests than at harvesttime. Philippine corn traders provide credit to many farmers.
Transaction costs are low for lender and borrower alike, and interest rates range
from 2 to 3 percent a month. (Interest rates on bank loans to corn traders are 1.5-2.0
percent a month.)

The terms of the loans are flexiblemost range from four to five monthsbut because
borrowers are vulnerable to the climate, it is common for traders to carry loans over
to a second or even a third harvest. Although the interest costs of trader credit are
higher than for loans from formal institutions, transaction costs are lower, and so the
total cost of borrowing is roughly the same.

The difference is that formal, targeted credit is simply not available to most corn
producers when it is needed. Noncorporate agents can smooth their consumption by
saving. Formal intermediaries have been slow to develop deposit services for this
sector, but a variety of informal arrangements allow farmers, small businesses, and
households to pooi their savings. The simplest such arrangement is the use of
money guardslocal people who safeguard cash for those who have no secure means
of doing so. Most such deposits earn no interest and are secured only by the word of
the money guard.

The guards maintain enough liquidity to return deposits at short notice. Some
deposits may be used by the guards for business transactions or for lending, but if so
the practice is seldom made public. Informal deposit services are also provided by
group savings associations. Deposits can be made at regular or irregular intervals.

Page 46
Funds are sometimes lent temporarily and then returned to the depositor at the end
of an agreed period, or they can be applied to the cost of providing a public good. A
popular arrangement is the rotating savings and credit association (ROSCA), which
is described in detail in Box 8.2. Members pool money by making periodic payments
into a fund, which then rotates among members as a lump-sum payout.

This allows at least some members to finance large expenditures sooner than if they
had relied on their own savings. Some ROSCAs even meet the demand for the
larger and longer-term loans that are needed to finance the cost of housing. The
popularity of such arrangements shows the potential for pooling individual savings
among small farmers or microentrepreneurs. In England and elsewhere building
societieswhich later became an important part of the formal financial systemoften
began as ROSCAs. Long-term finance Because informal lenders and their
customers are small and isolated, the risks of long-term lending are greater. Not
much term finance is provided by the informal sector, but some informal
arrangements have developed, mainly for housing finance. One example is key
money, as in Bolivia and Korea. A home buyer can lease his house in exchange for a
large cash payment. After an agreed period the house and the money are
reexchanged.

The interest that could have been earned on the money is the rental value of the
house. The recipient of key money may use it to finance a business venture or the
purchase of the house, thus circumventing the lack of conventional mortgage
finance. He must then save enough to return the 115 original amount to the renter by
the end of the rental period. Limitations of informal financial arrangements Despite
their success in providing financial services to small businesses that would otherwise
lack them, informal financial arrangements do not meet all the needs of the sector.
For example, such arrangements do not allow savings to be collected from more
than a small group of individuals well known to one another, and they do not move
funds over large distances.

Especially in rural areas local markets may be segmented from national markets,
which limits the supply of credit. Most loans are from family and friends or group
associations and are at low interest rates. The higher rates that moneylenders and
pawnbrokers charge are in large part due to the higher costs and risks associated
with informal loans. But some loans from moneylenders are at very high interest
rates because of the power imbalance that exists between borrower and lender. In
fact, much of the traditional criticism of moneylenders has derived from the high
interest charges and intimidating practices of loan sharkslenders who often finance
illegal activities. Except in housing finance, informal arrangements generally do not
provide term finance. These shortcomings may inhibit the longterm planning and
investment that are necessary if productivity is to rise.
PAGE 45
 The limitations of informal financial arrangements do not call for completely new
institutions. Indeed, formal intermediaries have often failed where informal
arrangements have prospered. Formal institutions, and the policymakers who set
their rules, might learn much about these markets by studying informal arrangements
more closely. Their essential features are these. Transactions are undertaken by
mutual consent, so the arrangements must meet the needs of both the buyer and the
seller of the service.

Transaction costs are kept to a minimum. And lenders are able to reduce the risk of
default by using knowledge that they have already gathered from other social or
business dealings. Sometimes informal arrangements provide a basis for
establishing links with formal institutions so as to provide a fuller range of services.
Semiformal finance Several approaches have been tried to overcome the limitations
of informal finance for the noncorporate sector. As discussed in Chapter 4, many 116
government programs of directed, low-cost lending have experienced serious
difficulties. Two types of lending arrangements, which fall in the gray area between
informal and formal finance, offer some promise.

These are group lending schemes and cooperative financial institutions, which can
be found the world over. Group lending schemes The funds for group lending
schemes can come from a commercial bank, a government development bank, or
private institutions. The role of the group varies.

In some cases the funds are lent to the group as a whole, which then allocates them
among members. Or loans maybe made directly to individual members of the group.
In either case the group provides a guarantee; it is answerable to the outside lender
for the repayment of loans. The idea is that by joining together, small borrowers can
reduce the costs of borrowing and improve their access to credit. The outside
lender's costs are reduced because lending to a group lowers the risk of dealing with
small businesses and circumvents the problems involved in selecting borrowers. The
groups themselves must be selective in accepting new members.

In this way, groups act as a substitute for information about borrowers and thereby
reduce the costs of processing loans. Group members encourage each other to
repay on time so that the rest can qualify for loans in the future. This directly reduces
the lender's commercial risks. The two most common means of providing group
accountability are (a) joint and several liability and (b) limited liability. Joint and
several liability encourages extremely careful selection of members because any
member can be held liable for the defaults of others. It may, however, deter the
comparatively wealthy from joining the group, since they have more to lose. In rural
Zimbabwe, schemes based on joint and several liability worked well in times of
average production but fared worse than other schemes in the same area in times of
drought and low production. The threat of default led farmers to withhold repayment
and hope for a general amnesty, since they would be, in any event, accountable for
other members' debts. Group lending schemes based on limited liability are more

Page 46
common. In Malawi and Nepal borrowers are required to put part of their loans in a
fund that would be forfeited if any member defaulted. If all members repay their
loans, these deposits are While the government struggled to create a viable rural
banking system in Bangladesh, a small private initiative was started in 1976 to help
the landless without normal bank collateral to obtain credit.

This program has become the Grameen (Rural) Bank. The unique operating
procedures of the Grameen Bank grew out of several earlier attempts to reach the
rural poor and were a sharp departure from traditional banking. The bank's
customers, who are restricted to the very poor, are organized into five-person
groups, and each group member must establish a regular pattern of weekly saving
before seeking a loan. The first two borrowers in a group must make several regular
weekly payments on their loans before other group members can borrow. Most loans
are to finance trading and the purchase of livestock. By February 1987 the Grameen
Bank was operating 300 branches covering 5,400 villages.

Nearly 250,000 persons were participating, among them an increasing number of

women, who accounted for about 75 percent of the total. The membership included
about 13 percent of households with less than half an acre of land in the areas in
which the bank was operating. Loans are smallon average, about 3,000 taka ($100)
in 1985. By the end of 1986 about Tkl.5 billion had been Box 8.3 The Grameen
Bank: an alternative approach to noncorporate finance in Bangladesh I I I returned.
This practice has resulted in a good record of repayment. In Malawi, where 10
percent of loans was held as security, 97 percent of seasonal credit disbursed
between 1969 and 1985 was recovered. In Nepal's Small Farmer Development
Program, which required security deposits of 5 percent, the repayment rate in 1984
was 88 percent. These repayment rates compare favorably with other small-
borrower credit programs. Another way of imposing limited liability is to link continued
access to credit with prompt repayment of existing loans (as is done in Ghana,
Malawi, and Zimbabwe). Group lending schemes have improved access to credit in
many countries, but they too have drawbacks. Groups have often been created at
the initiative of governments or private development agencies.

This top-down approach means that a scheme can be extended rapidly, but it may
undercut the force of local sanction. In one Latin American scheme, bank employees
formed groups from lines of borrowers at their windows. Such arbitrary selection is
unlikely to achieve group accountability. A second shortcoming is that the schemes
rely on external funds. Few collect deposits, partly because the supply of cheap
external funds reduces the intermediary's incentive to provide this service, but also
because deposit taking is viewed as too complex a task for unpaid group leaders.
Despite these drawbacks, some group lenders, such as the Grameen Bank of
Bangladesh, have an impressive record (see Box 8.3). Cooperative finance In group
PAGE 45
lending, borrowers and intermediaries are separate entities. In a cooperative
arrangement, borrowers and depositors own the intermediary.

In some countries such cooperatives fall outside the regulations that govern banks
and similar institutions. This can give financial cooperatives flexibility, but it can also
cut them off from the rediscounting and other facilities that are generally available to
other institutions. In many developing countries cooperatives operate under a
government department that supports them with funds, technical assistance, and
policy guidance. Government support is attractive to the 117 disbursed, of which
almost Tkl.2 billion had been recovered. Outstanding loans were thus about Tk300
million, with almost 70 percent held by women borrowers. In sharp contrast to the
Bangladesh commercial banking system, the Grameen Bank has experienced
excellent loan recovery. As of February 1987 about 97 percent of loans had been
recovered within one year after disbursement and almost 99 percent within two
years. This good performance is reportedly attributable to a combination of factors:
close supervision of field operations, dedicated service by bank staff, borrowing for
purposes that generate regular income, solidarity within groups, and repayment in
weekly installments. Another factor which encourages repayment is the borrower's
knowledge that the availability of future loans depends on the repayment of
borrowed funds. Bank staff meet weekly with groups to disburse loans, collect
savings deposits and loan payments, and provide training in financial responsibility.
This means high operating costs. The ratio of expenses to loans rose from 9 percent
in 1984 to 18 percent in 1986. These high costs have been partially offset by low-
cost funds from international agencies. I cooperatives' managers because it allows
lending to expand quickly, but it weakens the incentive of cooperative members to
provide their own finance.

When loans are made according to government directive, lenders may find it difficult
to collect. Such loans are often seen as grants and hence as resources that can be
spent on consumption. Often, cooperatives have been promoted as a counter to
usurious moneylenders and marketing agents. This has sometimes led the
advocates of cooperatives and credit unions to think that financial services can be
supplied to small producers for less than the real cost. Moreover, the goals of
government and cooperatives can differ greatly: governments often view
cooperatives as instruments for the conduct of broader policy.

In Africa, for example, a ministry wished to use the cooperative credit system to
channel low-interest funds from foreign donors to targeted programs. When the
ministry's plan was presented to the cooperative, the director declined because he
felt that the funds would never be recouped by his institution. The director was told to
reconsider or resign. The plan went into effect, repayment rates were extremely low,
and other cooperative lending programs were undermined.

The cooperative managed to refuse liability for nonrepayment, but the defaults
affected repayments of the institution's other loans. Similarly, the support of foreign

Page 46
donors can be a mixed blessing. Cooperatives may seem a suitable channel for
development funds, but they often end up with heavy liabilities and a bad collection
record. This mirrors the experience of development banks discussed in Chapter 4.
Cooperatives that lend internally generated funds with an eye on the rate of return do
better than those that are told what to do by outsiders. Even those loans that involve
no liability for the cooperative incur staff costs which may overburden a small
institution. Despite the difficulties, cooperatives are a good way of increasing access
to financial services. Their costs are often low because they use volunteer labor and
because they can reduce risk through group accountability and local sanction.

Where governments have been more concerned with the viability of cooperatives
than with social objectivesand where interest rate restrictions have been relatively
modestcooperatives have flourished and the supply of financial services has
broadened. In Togo, for example, savings in the credit union system grew by 25
percent a year and loans by 33 percent a year during 1977-86. Members elect a
board of directors, which decides on 118 interest rates, dividends on shares, and
lending policies

. The credit unions are federated, and they jointly manage a central fund, invest in
low-risk financial instruments, and mediate transfers between member unions with
surplus funds and those with deficits. Loans from the central fund to unions lacking
liquidity amounted to only 13 percent of its assets; deposits with financial institutions
accounted for 81 percent. Togo's credit unions, like informal suppliers of financial
services, live or die in the marketplace. But unlike informal intermediaries, they have
access to broader financial markets through their federated structure.

As a result, they can intermediate between regions and diversify their assets.
Improving finance for the noncorporate sector Although informal financial
arrangements do serve the needs of the noncorporate sector, they cannot be
regarded as adequate. Many of the attempts by governments and international
donors to increase the supply of finance to the noncorporate sector have focused on
providing access to affordable credit. They have foundered because they did not
take into account the true costs and risks of lending to the sector.

Lowering the costs and risks would help to put the sector within reach of formal
institutions. Greater competition between formal and informal lenders would improve
the allocation of resources. Improving the legal environment Legal reforms could
make it easier for small enterprises with relatively large financial needs to use formal
services. Such reforms include better definition and enforcement of property rights.

Squatters and small farmers with clear land titles would then have an acceptable
form of collateral. Property laws that limit inheritance by women or prohibit married
women from holding property in their own names limit their access to credit.
PAGE 45
 In many countries banking laws require women to obtain permission from their
husbands or fathers to borrow. In much of Africa such laws reduce agricultural
investment by placing an economically irrelevant barrier between the farmer and her
source of finance.

Laws meant to protect borrowers have often made loan contracts harder to enforce
and have thereby raised the risk of lending. Licensing and registration formalities and
taxation of businesses need to be kept in check. Small businesses in Peru,
Improvements in the provision of financial services might be gained by upgrading
informal arrangements and linking them to formal institutions. This implies building
upon, not supplanting, the existing arrangements. The linking of informal
arrangements with cooperatives is becoming increasingly common in Africa. In
Kinkala, a small rural town in the People's Republic of the Congo, a savings and
credit cooperative, Cooprative d'Epargne et de Credit (COOPEC), has 268
members. Informal arrangements operate in the local market. Among them is a
ROSCA with twenty-four members. Each member contributes 2,000 CFA francs a
month (about $4.50 in 1985) and receives the total collection of CFAF48,000 every
two years. This scheme has been linked with COOPEC so that ROSCA members
(who are also enrolled in the cooperative) make their monthly contribution to the
COOPEC manager, who deposits the total CFAF48,000 in a savings account.
ROSCA members are considered a good risk; their loan applications are looked
upon favorably by the COOPEC loan committee. In this way, COOPEC has
mobilized funds from its members and has satisfied credit demand.

An example of an apparently successful conversion of borrowing groups into a

cooperative bank is the Working Women's Forum of Madras. In 1978 thirty women
engaged in petty trade organized as a group to borrow from a commercial bank.
Despite the success of this and other affiliated groups of Indian women,
dissatisfaction with delays and inflexible disbursement and repayment schedules led
them to form and staff their own bank in 1981.

An example of upgrading that produced mixed results is the conversion of

indigenous savings and credit associations (isusu) into cooperatives in eastern
Nigeria. Cooperatives based on isusu performed better in most respects than the
rest. Members of these cooperatives, however, not only remained members of
indigenous savings and credit associations but also held most of their savings there.
This was partly because the government gave the cooperatives easy access to
funds, Governments in many developing countries have encouraged formal
institutions to serve the noncorporate sector.

The means have included lowcost rediscount facilities for targeted lending through
commercial banks, mandatory lending targets, and state-supported lending
institutions. As Chapter 4 pointed out, these policies have created weak institutions
and have thereby retarded the development of an efficient financial sector. They
have been particularly damaging to the farm sector. These failures have come to be

Page 46
widely iecognized, and a search for better solutions is under way. Government-
supported credit programs for the noncorporate sector can work.

This is shown by the Badan Kredit Kecamatan (BKK) program in Indonesia (see Box
8.4). The program provides loans to rural enterprises and other small borrowers. Its
viability has been maintained through interest rates that reflect lending costs and
through the use of local sanction to enforce repayment. Shared profits encourage
careful lending by BKK staff. Funds for the program have come from a government-
mandated rediscounting facility, but the scheme was designed to maintain its
independence.

Most of the successful formal institutions that serve the noncorporate sector,
however, take deposits. Some institutions have greatly improved their position by
doing so. The Banco Agricola in the Dominican Republic began to offer passbook
savings services in 1984 because it was in serious financial difficulty and urgently
needed funds.

By 1987 deposits had increased more than twentyfold. Although 60 percent of the
depositors were previous borrowers from the institution, the rest were a new clientele
who demanded only a safe and convenient store for liquidity. Mobilization of
voluntary deposits is desirable for several reasons.

First, resource allocation can be improved if noncorporate agents have good deposit
opportunities with positive real rates of interest and low transaction costs. Second,
the flow of 119 for example, are forced to operate clandestinely which reduced their
incentive to collect deposits because legal status costs too much. So regulation and
undercut their independence. Many cooperafails even in its narrow objective.
Meanwhile, the tive members, seeing that this new source of fieconomic welfare of
suppliers and customers is re- nance was risky, continued to rely on the informal
duced because businesses would have better ac- arrangements. If the advantages
of formality are cess to formal credit if they were properly regis- visible and
worthwhile, clients will participate and tered and licensed. the institution will prosper.
If not, they will return to the informal arrangements.

Links between informal and formal finance Formal intermediation for the
noncorporate sector I through the organization of retired military officers cost 47.5
percent a month. The BKK's effective monthly rate is about 7.5 percent. A maximum
of one week elapses between loan application and disbursement or rejection. If the
first loan is repaid on time, new loans may be disbursed on the same day as the
application. To get a loan, borrowers must fill out a simple one-page form and
receive the approval of their village leader. No collateral is required. The system
relies upon character references from local officials and peer pressure to encourage
repayment. The BKK reduces risk by making initial, short-term loans of about $5.
PAGE 45
The administrative costs would seem prohibitive. But these loans introduce villagers
to the financial system and enable them to graduate to larger loans. Most clients
agreed that the greatest incentive for repaying on time was the expectation of getting
another loan. Each local BKK is an independent unit, not a bank branch. The staff of
the regional development bank supervises the local units carefully. Salaries of BKK
staff are low, but motivation to expand the portfolio and maintain a good collection
rate is high, since 10 percent of a BKK's profits are divided among its staff. If a BKK
goes bankrupt, staff members are no longer paid. The main source of BKK funds has
been loans from the regional development bank.

Each loan to borrowers, however, has a mandatory savings component that earns
interest and can be withdrawn when the loan is fully repaid. Recently the BKK began
a voluntary savings program in nine units. More than $30,000 was raised within
seven months, with an average savings account of only $9. Most of these voluntary
savers were not BKK borrowers. The program will be duplicated at 400 of the
healthiest units in 1988-89. I resources is typically from small savers to highyield
activities in the corporate sector.

Inadequate deposit facilities can block the most important channel for this flow.
Third, financial institutions require the independence and discipline that only
voluntary deposits can provide. Institutions gain from extra information on potential
borrowers, from the relationships that bind intermediary and client, and from the
borrowers' knowledge that loans come from neighbors and not distant government or
international agencies.

A strengthening of formal financial institutions (as discussed in Chapter 7) will be

needed if they 120 are to provide sustainable financial services to the noncorporate
sector. This means better management and improved incentives for employees.
Innovation will be needed to contain the added risks of providing finance to the
noncorporate sector. Group lending is one example. Another is the ratchetmg of
loansmaking small loans initially and bigger ones after the borrower has proved
creditworthy. This has been the practice of many group schemes and of both the
Grameen Bank and the BKK. Formal institutions could extend more of their services
to the noncorporate sector if it was profitable to do so. This means improving the
ability of Box 8.4 The Badan Kredit Kecamatan: financial innovation for the
noncorporate sector in Indonesia A government project in central Java, the Badan
Kredit Kecamatan (BKK), lends tiny sums without collateral, largely to middle-aged
peasant women. The BKK takes no longer than a week to process the one-page
loan application form and does not supervise the loans.

It sounds like a recipe for disaster, yet the BKK is one of the most successful banking
operations of its kind in the world. More than 35 percent of central Java's 8,500
villages are serviced by almost 500 subdistrict BKK units and 3,000 village posts.

Page 46
 As of December 31, 1987, the BKK had 516,000 outstanding loans, 90 percent of
which were for less than $60. The BKK earned $1.4 million in profits in 1987a 14
percent return on the consolidated average outstanding portfolio for that year.

Although the delinquency rate appears to be highabout 20 percent of outstanding

loansa closer look reveals that about three-quarters of arrears are several years old
and should be written off.

If these loans were subtracted, the actual repayment rate would be around 95
percent. (The BKK resists writing off bad debts because it feels that this sends the
wrong message to borrowers.) Starting in 1970, at the initiative of the governor of
central Java, a BKK unit was created in each of the subdistricts (kecamatan) with an
initial loan of 1 million rupiah.

The loan was provided by the provincial govL ernment through the regional
development bank at 1 percent interest per month.

Additional funds are borrowed from the regional development bank, also at 1 percent
interest per month. To bypass restrictions and paperwork, these BKK units were
classified as nonbanks. This enabled the BKK to charge interest rates high enough
to cover its costs, to avoid credit allocation, and to ignore traditional collateral
requirements.

BKK loans are relatively cheap. Daily credit from moneylenders costs 20 percent a
day. Monthly loans banks to reduce loan losses and establishing clear property rights
for borrowers. Above all, profitability requires reducing directed credit programs with
interest rate restrictions, since these fail to reflect the costs and risks involved in
lending to the noncorporate sector.

Most of the financial needs of the noncorporate sector are met quite well by a wide
variety of informal arrangements. Providers of informal services rely on their
knowledge of their customers and on local sanction to contain credit risk. But some
informal financial arrangements are costly, and they offer limited alternatives in
instruments and suppliers.

Governments, in their efforts to overcome these shortcomings, have underestimated

the difficulties of supplying services to the sector. Government programs have
benefited the few people fortunate enough to receive cheap credit, but in general
they have failed to reduce costs or to facilitate the transfer of resources from those
with surplus funds to those who can make use of them or to promote viable financial
institutions.

PAGE 45
Financial services to rural areas and to the urban poor would benefit from better
legal systems, more clearly defined property rights, and better links between informal
and formal financial institutions

If you take any economic or social variable like child mortality, foreign-exchange
reserves, school enrollment, or GDP growth, India has moved in the right direction
since 1991. However, in 2011, the only variable which is exactly where it was in 1991
is the percentage of labor force employed in the informal sector, which is a whopping
93 per cent. Most Indians in the workforce are self-employed, often self-under-
employed. Nearly 8 million to 10 million join the workforce each year.

The unorganized workforce in India also has no social security benefits with them;

another section that is subject to heavy exploitation is the women workforce of which

96% is in the unorganized sector.

Labor market flexibility and social protection are two of the great challenges facing
the system of Industrial relations in India and a system to match the demands of
globalization is rife with many difficulties.

The vast majority of the workforce including agricultural labour, construction labour

and labour in traditional leather tanning, handloom, fishing, forestry, salt making,

household industry etc., as also village artisans, coming under the generic

categories of unorganised sector are wholly out of any reckoning in the various

statutory laws in the country. These workers are unprotected by legislation and most

of them tend to be poor.

The workers in the unorganized sector have no regular jobs or assured income their

primary need is employment security and improvements in quality of employment.

In India, unemployment per-Se is not the main problem. Many people working in

unorganized sector, is characterized by low earnings, poor working conditions and

lack of social security protection.

Deregulation has made no impact at the state level. The systems of buying and

selling land, getting a ration card or your security back, and rent control acts all need

a thorough revision. One can set up an industry worth billions of rupees in India

Page 46
 without any license today, but a farmer can neither set up a brick kiln unit, nor a rice

selling plant, nor a cold storage without bribing the officials. In urban informal sector

also there are many legal hurdles.

SUGGESTIONS
There are numerous laws to tackle the problems but the issue is with the

implementation of these laws. The other issue is that awareness regarding these

laws and entitlements is not there even with the organized workforce leave aside the

unorganized workforce which is illiterate.

This reiterates the fact that education and awareness regarding the labour laws is

essential for the entire labour work force.

1. This Recommendation provides guidance to Members to:

(a) facilitate the transition of workers and economic units from the
informal to the formal economy, while respecting workers fundamental rights
and ensuring opportunities for income security, livelihoods and
entrepreneurship;

(b) promote the creation, preservation and sustainability of enterprises

and decent jobs in the formal economy and the coherence of macroeconomic,
employment, social protection and other social policies; and

(c) prevent the informalization of formal economy jobs.

2. For the purposes of this Recommendation, the term informal economy:

(a) refers to all economic activities by workers and economic units that
are in law or in practice not covered or insufficiently covered by formal
arrangements; and

(b) does not cover illicit activities, in particular the provision of services
or the production, sale, possession or use of goods forbidden by law, including
PAGE 45
 the illicit production and trafficking of drugs, the illicit manufacturing of and
trafficking in firearms, trafficking in persons, and money laundering, as defined in
the relevant international treaties.

3. For the purposes of this Recommendation, economic units in the informal

economy include:

(a) units that employ hired labour;

(b) units that are owned by individuals working on their own account,
either alone or with the help of contributing family workers; and

(c) cooperatives and social and solidarity economy units.

4. This Recommendation applies to all workers and economic units

including enterprises, entrepreneurs and households in the informal economy, in
particular:

(a) those in the informal economy who own and operate economic
units, including:

(i) own-account workers;

(ii) employers; and

(iii) members of cooperatives and of social and solidarity

economy units;

(b) contributing family workers, irrespective of whether they work in

economic units in the formal or informal economy;

(c) employees holding informal jobs in or for formal enterprises, or in or

for economic units in the informal economy, including but not limited to those in
subcontracting and in supply chains, or as paid domestic workers employed by
households; and

(d) workers in unrecognized or unregulated employment relationships.

5. Informal work may be found across all sectors of the economy, in both
public and private spaces.

6. In giving effect to the provisions of Paragraphs 2 to 5 above, and given the

diversity of the informal economy across member States, the competent authority

Page 46
 should identify the nature and extent of the informal economy as described in this
Recommendation, and its relationship to the formal economy. In so doing, the
competent authority should make use of tripartite mechanisms with the full
participation of the most representative employers and workers organizations, which
should include in their rank, according to national practice, representatives of
membership-based representative organizations of workers and economic units in
the informal economy.

7. In designing coherent and integrated strategies to facilitate the transition to

the formal economy, Members should take into account the following:

The diversity of characteristics, circumstances and needs of workers

and economic units in the informal economy, and the necessity to address such
diversity with tailored approaches.

The specific national circumstances, legislation, policies, practices and

priorities for the transition to the formal economy.

The fact that different and multiple strategies can be applied to

facilitate the transition to the formal economy.

The need for coherence and coordination across a broad range of

policy areas in facilitating the transition to the formal economy.

(e) the effective promotion and protection of the human rights of all
those operating in the informal economy;

(f) the fulfilment of decent work for all through respect for the
fundamental principles and rights at work, in law and practice;

(g) the up-to-date international labour standards that provide guidance

in specific policy areas (see Annex);

(h) the promotion of gender equality and non-discrimination;

(i) the need to pay special attention to those who are especially
vulnerable to the most serious decent work deficits in the informal economy,
including but not limited to women, young people, migrants, older people,

PAGE 45
 indigenous and tribal peoples, persons living with HIV or affected by HIV or
AIDS, persons with disabilities, domestic workers and subsistence farmers;

(j) the preservation and expansion, during the transition to the formal
economy, of the entrepreneurial potential, creativity, dynamism, skills and
innovative capacities of workers and economic units in the informal economy;

(k) the need for a balanced approach combining incentives with

compliance measures; and

(l) the need to prevent and sanction deliberate avoidance of, or exit
from, the formal economy for the purpose of evading taxation and the
application of social and labour laws and regulations.

8. Members should undertake a proper assessment and diagnostics of

factors, characteristics, causes and circumstances of informality in the national
context to inform the design and implementation of laws and regulations, policies
and other measures aiming to facilitate the transition to the formal economy.

9. Members should adopt, review and enforce national laws and regulations
or other measures to ensure appropriate coverage and protection of all categories of
workers and economic units.

10. Members should ensure that an integrated policy framework to facilitate

the transition to the formal economy is included in national development strategies or
plans as well as in poverty reduction strategies and budgets, taking into account,
where appropriate, the role of different levels of government.

11. This integrated policy framework should address:

(a) the promotion of strategies for sustainable development, poverty

eradication and inclusive growth, and the generation of decent jobs in the formal
economy;

(b) the establishment of an appropriate legislative and regulatory

framework;

(c) the promotion of a conducive business and investment

environment;

Page 46
 (d) respect for and promotion and realization of the fundamental
principles and rights at work;

(e) the organization and representation of employers and workers to

promote social dialogue;

(f) the promotion of equality and the elimination of all forms of

discrimination and violence, including gender-based violence, at the workplace;

(g) the promotion of entrepreneurship, micro, small and medium-sized

enterprises, and other forms of business models and economic units, such as
cooperatives and other social and solidarity economy units;

(h) access to education, lifelong learning and skills development;

(i) access to financial services, including through a regulatory

framework promoting an inclusive financial sector;

(j) access to business services;

(k) access to markets;

(l) access to infrastructure and technology;

(m) the promotion of sectoral policies;

(n) the establishment of social protection floors, where they do not

exist, and the extension of social security coverage;

(o) the promotion of local development strategies, both rural and urban,
including regulated access for use of public space and regulated access to
public natural resources for subsistence livelihoods;

(p) effective occupational safety and health policies;

(q) efficient and effective labour inspections;

(r) income security, including appropriately designed minimum wage

policies;

(s) effective access to justice; and

PAGE 45
 (t) international cooperation mechanisms.

12. When formulating and implementing an integrated policy framework,

Members should ensure coordination across different levels of government and
cooperation between the relevant bodies and authorities, such as tax authorities,
social security institutions, labour inspectorates, customs authorities, migration
bodies and employment services, among others, depending on national
circumstances.

13. Members should recognize the importance of safeguarding the

opportunities of workers and economic units for income security in the transition to
the formal economy by providing the means for such workers or economic units to
obtain recognition of their existing property as well as by providing the means to
formalize property rights and access to land.

14. In pursuing the objective of quality job creation in the formal economy,
Members should formulate and implement a national employment policy in line with
the Employment Policy Convention, 1964 (No. 122), and make full, decent,
productive and freely chosen employment a central goal in their national
development and growth strategy or plan.

15. Members should promote the implementation of a comprehensive

employment policy framework, based on tripartite consultations, that may include the
following elements:

(a) pro-employment macroeconomic policies that support aggregate

demand, productive investment and structural transformation, promote
sustainable enterprises, support business confidence, and address inequalities;

(b) trade, industrial, tax, sectoral and infrastructure policies that

promote employment, enhance productivity and facilitate structural
transformation processes;

(c) enterprise policies that promote sustainable enterprises and, in

particular, the conditions for a conducive environment, taking into account the
resolution and Conclusions concerning the promotion of sustainable enterprises
adopted by the International Labour Conference at its 96th Session (2007),
including support to micro, small and medium-sized enterprises and

Page 46
 entrepreneurship, and well-designed, transparent and well-communicated
regulations to facilitate formalization and fair competition;

(d) labour market policies and institutions to help low-income

households to escape poverty and access freely chosen employment, such as
appropriately designed wage policies including minimum wages, social
protection schemes including cash transfers, public employment programmes
and guarantees, and enhanced outreach and delivery of employment services to
those in the informal economy;

(e) labour migration policies that take into account labour market needs
and promote decent work and the rights of migrant workers;

(f) education and skills development policies that support lifelong

learning, respond to the evolving needs of the labour market and to new
technologies, and recognize prior learning such as through informal
apprenticeship systems, thereby broadening options for formal employment;

(g) comprehensive activation measures to facilitate the school-to-work

transition of young people, in particular those who are disadvantaged, such as
youth guarantee schemes to provide access to training and continuing
productive employment;

(h) measures to promote the transition from unemployment or inactivity

to work, in particular for long-term unemployed persons, women and other
disadvantaged groups; and

(i) relevant, accessible and up-to-date labour market information

systems.

16. Members should take measures to achieve decent work and to respect,
promote and realize the fundamental principles and rights at work for those in the
informal economy, namely:

(a) freedom of association and the effective recognition of the right to

collective bargaining;

(b) the elimination of all forms of forced or compulsory labour;

PAGE 45
 (c) the effective abolition of child labour; and

(d) the elimination of discrimination in respect of employment and

occupation.

17. Members should:

(a) take immediate measures to address the unsafe and unhealthy

working conditions that often characterize work in the informal economy; and

(b) promote and extend occupational safety and health protection to

employers and workers in the informal economy.

18. Through the transition to the formal economy, Members should

progressively extend, in law and practice, to all workers in the informal economy,
social security, maternity protection, decent working conditions and a minimum wage
that takes into account the needs of workers and considers relevant factors,
including but not limited to the cost of living and the general level of wages in their
country.

19. In building and maintaining national social protection floors within their
social security system and facilitating the transition to the formal economy, Members
should pay particular attention to the needs and circumstances of those in the
informal economy and their families.

20. Through the transition to the formal economy, Members should

progressively extend the coverage of social insurance to those in the informal
economy and, if necessary, adapt administrative procedures, benefits and
contributions, taking into account their contributory capacity.

21. Members should encourage the provision of and access to affordable

quality childcare and other care services in order to promote gender equality in
entrepreneurship and employment opportunities and to enable the transition to the
formal economy.

22.Members should take appropriate measures, including through a

combination of preventive measures, law enforcement and effective sanctions, to
address tax evasion and avoidance of social contributions, labour laws and
regulations. Any incentives should be linked to facilitating the effective and timely
transition from the informal to the formal economy.

Page 46
 23. Members should reduce, where appropriate, the barriers to the transition
to the formal economy and take measures to promote anti-corruption efforts and
good governance.

24. Members should provide incentives for, and promote the advantages of,
effective transition to the formal economy, including improved access to business
services, finance, infrastructure, markets, technology, education and skills
programmes, and property rights.

25. With respect to the formalization of micro and small economic units,
Members should:

(a) undertake business entry reforms by reducing registration costs and

the length of the procedure, and by improving access to services, for example,
through information and communication technologies;

(b) reduce compliance costs by introducing simplified tax and

contributions assessment and payment regimes;

(c) promote access to public procurement, consistent with national

legislation, including labour legislation, through measures such as adapting
procurement procedures and volumes, providing training and advice on
participating in public tenders, and reserving quotas for these economic units;

(d) improve access to inclusive financial services, such as credit and

equity, payment and insurance services, savings, and guarantee schemes,
tailored to the size and needs of these economic units;

(e) improve access to entrepreneurship training, skills development

and tailored business development services; and

(f) improve access to social security coverage.

26. Members should put in place appropriate mechanisms or review existing

mechanisms with a view to ensuring compliance with national laws and regulations,
including but not limited to ensuring recognition and enforcement of employment
relationships, so as to facilitate the transition to the formal economy.

PAGE 45
 27. Members should have an adequate and appropriate system of inspection,
extend coverage of labour inspection to all workplaces in the informal economy in
order to protect workers, and provide guidance for enforcement bodies, including on
how to address working conditions in the informal economy.

28. Members should take measures to ensure the effective provision of

information, assistance in complying with the relevant laws and regulations, and
capacity building for relevant actors.

29. Members should put in place efficient and accessible complaint and
appeal procedures.

30. Members should provide for preventive and appropriate corrective

measures to facilitate the transition to the formal economy, and ensure that the
administrative, civil or penal sanctions provided for by national laws for non-
compliance are adequate and strictly enforced.

31. Members should ensure that those in the informal economy enjoy freedom
of association and the right to collective bargaining, including the right to establish
and, subject to the rules of the organization concerned, to join organizations,
federations and confederations of their own choosing

32. Members should create an enabling environment for employers and

workers to exercise their right to organize and to bargain collectively and to
participate in social dialogue in the transition to the formal economy

33. Employers and workers organizations should, where appropriate, extend

membership and services to workers and economic units in the informal economy

34. In designing, implementing and evaluating policies and programmes of

relevance to the informal economy, including its formalization, Members should
consult with and promote active participation of the most representative employers
and workers organizations, which should include in their rank, according to national
practice, representatives of membership-based representative organizations of
workers and economic units in the informal economy

35. Members and employers and workers organizations may seek the
assistance of the International Labour Office to strengthen the capacity of the
representative employers and workers organizations and, where they exist,

Page 46
 representative organizations of those in the informal economy, to assist workers and
economic units in the informal economy, with a view to facilitating the transition to the
formal economy

36. Members should, in consultation with employers and workers

organizations, on a regular basis:

(a) where possible and as appropriate, collect, analyse and

disseminate statistics disaggregated by sex, age, workplace, and other specific
socio-economic characteristics on the size and composition of the informal
economy, including the number of informal economic units, the number of
workers employed and their sectors; and

(b) monitor and evaluate the progress towards formalization.

37. In developing or revising the concepts, definitions and methodology used

in the production of data, statistics and indicators on the informal economy, Members
should take into consideration relevant guidance provided by the International
Labour Organization, in particular and as appropriate, the guidelines concerning a
statistical definition of informal employment adopted by the 17th International
Conference of Labour Statisticians in 2003 and their subsequent updates.

38. Members should give effect to the provisions of this Recommendation, in

consultation with the most representative employers and workers organizations,
which should include in their rank, according to national practice, representatives of
membership-based representative organizations of workers and economic units in
the informal economy, by one or a combination of the following means, as
appropriate;

(a) national laws and regulations;

(b) collective agreements;

(c) policies and programmes;

(d) effective coordination among government bodies and other

stakeholders;

PAGE 45
 (e) institutional capacity building and resource mobilization; and

(f) other measures consistent with national law and practice.

39. Members should review on a regular basis, as appropriate, the

effectiveness of policies and measures to facilitate the transition to the formal
economy, in consultation with the most representative employers and workers
organizations, which should include in their rank, according to national practice,
representatives of membership-based representative organizations of workers and
economic units in the informal economy.

40. In establishing, developing, implementing and periodically reviewing the

measures taken to facilitate the transition to the formal economy, Members should
take into account the guidance provided by the instruments of the International
Labour Organization and the United Nations relevant to the informal economy listed
in the Annex.

41. Nothing in this Recommendation should be construed as reducing the

protections afforded to those in the informal economy by other instruments of the
International Labour Organization.

42. The Annex may be revised by the Governing Body of the International
Labour Office. Any revised Annex so established, once approved by the Governing
Body, shall replace the preceding annex and shall be communicated to the Members
of the International Labour Organization .

Conclusions

accounts for a sizeable number of workers in India across different industry groups and

states. The concept of informal sector and informal workers proposed by NCEUS is more

appropriate in the context of Indian statistical system and it better compatible with

international definition of informal sector.

The estimated number of informal sector workers in 2004-05 was 394.90 million in India

contributing 86 percent of total workers. Over the year the proportion of rural informal sector

Page 46
workers decreased and the opposite happened in urban areas. It is observed between the

study period of 1999-00 to 2004-05 that the growth rate of formal sector workers in rural

areas in all categories is higher than growth rate in informal sector workers but the reverse

happened in urban area. The growth rate of urban informal sector is higher than formal

sector workers. The proportion of informal sector workers in the agriculture sector declined

over the years but in industry and services sector the proportion of informal sector workers

increased between 1999-2000 and 2004-05. There is positive and significant correlation

between inform sector employment and the incidence of poverty in the states. The

percentage share of informal sector workers in the poor states is more than developed

states. 12 The definition of informal sector workers is more about the characteristics of the

enterprise rather than the characteristics of the worker. The concept of Informal Worker is

based on the personal characteristic of the worker rather than enterprise. Informal workers

consist of 92.38 percent of total workers in India in 2004-05. Around half of the formal sector

workers are informal workers. This indicates that casualisation or the amount of contractual

labour increases in the formal sector which is a matter of great concern for policy makers.

Since the formal sector unable absorb the vast labour force of India the policy makers should

think to bring the workers in the informal segment to the mainstream.

The evidence we have presented is broadly consistent with the dual view of informality:

informal firms stay permanently informal, they hire informal workers for cash, buy their inputs

for cash, and sell their products for cash, they are extremely unproductive, and they are

unlikely to benefit much from becoming formal. This approach generates the strong

prediction that the cure for informality is economic growth. The evidence strongly supports

this prediction: informality declines, although slowly, with development. This approach

suggests that structural policies designed to promote formality should be introduced with

caution. Their wisdom depends, in part on whether they encourage formalization, or

discourage informal activity. Thus the simplification of business registration advocated by De

PAGE 45
Soto (1989) is probably a good idea, even though the evidence suggests that it is unlikely to

have large benefits. On the other hand, we are skeptical of all policies that might tax or

regulate informal firms. Rather than encourage informal firms to become formal, such

policies may have the effect of driving them out of business, leading to poverty and

destitution of informal workers and entrepreneurs. The recognition of the fundamental fact

that informal firms are extremely inefficient recommends extreme caution with policies that

impose on them any kind of additional costs. There is accumulating evidence that growth

that kills the informal sector is driven by the formation and expansion of formal firms

managed by educated entrepreneurs. Uneducated entrepreneursin both informal and

formal sectors generally run small and inefficient firms; educated entrepreneurs and

managers run larger and more-efficient firms. This is the dark side of dualism: informal

economies are so large in poor countries because their entrepreneurs are so unproductive.

The evidence suggests that an important bottleneck to economic growth is not the supply of

better-educated workers; indeed, at least on many observable characteristics the workers

are rather similar in informal and formal firms. Rather, the bottleneck is the supply of

educated entrepreneurspeople who can run productive businesses. These entrepreneurs

create and expand modern businesses with which informal firms, despite all their benefits of

avoiding taxes and regulations, simply cannot compete. This is how the informal economy

dies out in the process of development. From this perspective, the policy message for how to

grow the formal economy and shrink the informal one is to increasewhether through

immigration or education and trainingthe supply of educated entrepreneurs.

Page 46
 ACKNOWLEDGEMENT

I would like to express my special thanks of

gratitude to my teacher M/s Sukhjinder Kaur
as well as our principal who gave me the
golden opportunity to do this wonderful
project on the topic Formal and Informal
sector in financing, which also helped me in
doing a lot of Research and i came to know
about so many new things I am really
thankful to them.
Secondly i would also like to thank my
parents and friends who helped me a lot in
finalizing this project within the limited time
frame.

With regards
Sandeep Kaur

PAGE 45
 BIBLIOGRAPHY

Alonzo, R.P. "Trends in poverty and labour market outcomes in the Metro
Manila area", in Gerry Rodgers (ed.) Urban poverty and the labour market:
Access to jobs and incomes in Asian and Latin American cities, (Geneva,
ILO, 1989)

pp. 173-200. Ashe, J. "Extending credit and technical assistance to the

smallest enterprises" in Bromley, R. (ed.) Planning for small enterprises in
Third World cities (New York, Pergamon Press, 1985)

Baldeaux, Dieter Entwicklungspotentiale in Slumgebieten, Studie im

Auftrag des BMZ (Munich, Cologne, London, Weltforum Verlag, 1983

Banerjee, Biswajit "The role of the informal sector in the migration

process: A test of probabilistic migration models and labour market
segmentation for India", Oxford Economic Papers, 1983

Vol. 35. Banerjee, Biswajit "The unorganised sector and the planner" in
Bagchi, A.K. (ed.) Economy, society and polity: essays in the political
economy of Indian planning (Delhi, Oxford University Press, 1988).

Bienefeld, M. "The informal sector and women's oppression", in Institute

of Development Studies Bulletin, Vol. 42, No. 3, 1981.

Page 46
 Cameron, J. and Irfan, M. Enabling people to help themselves, ILO/ARTEP
study, New Delhi, 1991,

chapters 5 and 6. Chandra, Navin. "Working conditions of Brick-Kiln

workers, Paper presented the National Seminar on Social Security for
Unorganised Labour, New Delhi, 14-16 March 1983.

Cohen, S.I. and Havinga, Ivo C. "Microeconomic analysis of the informal

sector- Results of sample surveys", The Pakistan Development Review,
Vol. 27, No. 4, Part II, Winter 1988

pp. 605- 617. Dhesi, A.S. and Wadhwa, Urvashi. "Productivity earnings
and employment potential of informal sector - A case study of Nangal
(Punjab), Indian Journal of Industrial Relations, Vol. 20, No. 1, July 1984,

pp. 1-16. Evers, H.D. "Urban poverty and labour supply strategies in
Jakarta", in Gerry Rodgers (ed.) Urban poverty and the labour market:
Access to jobs and incomes in Asian and Latin American cities, (Geneva,
ILO, 1989),

pp. 145-172. Evers, H.D. "Ekonomi bayangan produksi subsistem, dan

sektor informal", in Prisma, Vol. 20, No. 5, May 1991.

Garella, Veena and Bhatnagar, Ritu. The Urban Informal Sector,

Department of Urban and Regional Planning, School of Planning and
Architecture, New Delhi, January 1987.

151 Geertz, Clifford "The bazaar economy: information and change in

peasant marketing", American Economic Review, May 1978.

Gopal, Bhargawa. Rule of Government in Informal Sector, Institute of

Applied Manpower Research, New Delhi, February 1988.

Haan, H.C. Urban informal sector information: Needs and methods, edited
by Celestin, J.-B. (Geneva, ILO, 1989). Harriss, J. "Labour absorption in
'small-scale' private sector services, Paper prepared for the ILO/Economic
Planning Unit, Government of Malaysia, Project on Malaysian Human
Resource Development Plan, 1989.

Harriss, J. "Character of an urban economy: Small-scale production and

labour markets in Coimbatore", in Economic and Political Weekly, Vol. 17,
Nos. 23-24, (Bombay) June 1982,

pp. 945-1002. Harriss, John "Small-scale production and labour markets",

Economic and Political Weekly, 1982, Vol. 17, Nos. 23-24. Hemmer, H.R.
PAGE 45
and Mannel, C. On the economic analysis of the urban informal sector,
Discussion Paper No. 6 (University of Giessen, 1987).

Page 46