Demonetisation helped kickstart formalisation | Economic Times

by K SubramanianAs we mark the 4th anniversary of demonetisation in India, policymakers need to examine the benefits of formalisation that has manifested through various policy measures starting with demonetisation.Formalisation involves multiple facets. First, bringing hidden money into the formal economy. Second, converting informal sector jobs into formal sector jobs. Finally, getting informal sector firms into the formal economy. Each step complements the others. On the one hand, formalisation of firms and workers enhances their profits and wages respectively while increasing their resilience. On the other hand, bringing hidden money into the formal economy helps reduce income inequality, thereby putting more income in the hands of the poor, who have a higher marginal propensity to consume. Formalisation, thus, enables greater demand creation in the economy. Furthermore, as workers and firms in the informal sector are far more vulnerable than those in the formal sector, formalisation strengthens the economy by providing it inherent resilience.As data from the World Inequality Database demonstrates, inequitable growth from 2004 to 2014 exacerbated inequality in the Indian economy. While the wealthy top 1% accounted for 18.4% of national income in 2004, this proportion increased significantly by 2014 with the super-rich cornering 21.3% of national income by 2014. Over the same decade, the proportion of national wealth accruing to the bottom 50% decreased from 18.8% in 2004 to 14.7% in 2014. Thus, from 2004-14, a significant proportion of national wealth got transferred away from the bottom 50% to the top 1%. As documented in Chapter 3 of Volume 1 of the Economic Survey 2019-20, these wealth transfers from the poor to the ultra-rich manifested primarily from the increase in cronyism and corruption during this period. Subsequent policy measures have addressed this pattern of inequitable growth. During demonetisation, non-profit organizations and non-corporates formed the second-largest category of entities in terms of the average cash deposited. While they account for only 4.6% of the PAN numbers, the cash deposited by them accounted for a disproportionate 16.2%. This is crucial because such non-profit organizations and non-corporates can often become the vehicles for the unholy trinity of tax evasion, wilful default and money laundering. In fact, as the Economic Survey 2019-20 (Ch 7 Vol 1) demonstrates, related party transactions are used by wilful defaulters. The rooting out of shell entities, therefore, helps the fight against these trinity of menaces. Following demonetisation, 3.8 lakh companies and 4.5 lakh directors associated with such companies have been struck off under sections 248(1)(c) and 248(1)(c) of the Companies Act respectively. Cumulatively, surveys conducted by the tax authorities in 63691 cases revealed undisclosed income of about Rs 85,000 crore.Formalisation of the economy has helped in bringing crores of workers into the formal sector. The Economic Survey 2019-20 (Ch 10 Vol 2 pages 283-288) shows the significant strides that India has made in formalization of the workforce. Using data from the Periodic Labour Force Survey of 2017-18 and the Employment Unemployment Survey of 2011-12, the Economic Survey highlighted that the share of regular wage/salaried employees increased by 5% from 18% in 2011-12 to 23% in 2017-18. In absolute terms, salaried employees significantly jumped by 2.62 crore, with 1.21 crore of this manifesting in rural areas and 1.39 crore in urban areas. The proportion of women workers in salaried employees increased by 8% from 13% in 2011-12 to 21% in 2017- 18 with addition of 0.71 crore new jobs for female workers in this category. This increase in female salaried employees is remarkable given the significantly lower rate of labour force participation by women in India.This increase in salaried workers manifested primarily due to the decrease in casual labour, which declined by an identical 5% from 30% in 2011-12 to 25% in 2017-18. This decline in causal workers was primarily accounted for by the decline in casual labour in rural areas. The proportion of unpaid family labour (i.e. helpers) declined from 18% in 2011-12 to 14% in 2017-18, thereby resulting in a decrease in this vulnerable worker category by 2.17 crore. This change was absorbed by the increase in own account workers and employers.The proportion of workers in organized sector increased from 17.3% in 2011- 12 to 19.2% in 2017-18. In actual terms, the number of workers in the organized sector increased to about 9.05 crore workers in 2017-18, an increase of 0.87 crore over 2011-12. This was mainly due to the increase in formal employment, the share of which in organised sector increased from 45% in 2011-12 to 49% in 2017- 18. Total formal employment increased from 8% to 9.98% during this period. In absolute terms, the number of workers with formal employment increased from 3.8 crore in 2011-12 to 4.7 crore in 2017-18. Finally, the estimates of share of workers in informal sector in non-agriculture sectors declined from 77.5 % in 2004-05 to 68.4% in 2017-18, with the decline being more pronounced among females. As wages of formal workers are significantly higher than that of informal workers, the increase in formalisation of the workforce will help foster long-run demand in the economy.Finally, formalisation helps firms, especially the small ones. A World Bank study (Klapper et al. 2019) shows that an important reason why firms in the sector remain unproductive is that they rely heavily on cash. The tracking of accounts payable, inventory and accounts receivables, for instance, is far more difficult when transactions are primarily done using cash.As working capital requirements as a proportion of sales is far greater for small firms, the productivity improvements stemming from digitisation create significant productivity improvements for small firms when they formalise. In this context, the sharp increase in digital transactions following demonetisation benefits firms significantly by enhancing productivity and thereby building resilience.To continue to build resilience against unanticipated shocks and enhance productivity, policymakers should redouble efforts to formalise the economy further.K Subramanian is the Chief Economic Advisor to the Government of India.