Annex 3E: A Granular Look at the Informal Sector

The analysis plotted the share of informal employment and the share of informal firms by state and union territory, sorted by GDP per capita from high to low. As Ulyssea (2018) suggests, informal employment and informal firms do not necessarily advance and slide back together in different places. Similar results are found using Indian data. The share of informal employment surpassed 95 percent in Andaman, Lakshadweep, and Mizoram, but barely reached 40 percent in Arunachal and in Daman and Diu. The share of informal firms, meanwhile, was highest in Andaman, Manipur, and Meghalaya, but lowest in Dadra, Daman and Diu, and Goa. The distribution of informal workers and informal firms varies largely, but firm informality and employment informality do not necessarily trend in the same direction. Delhi, for example, ranks 4th lowest in the share of informal firms, but only 18th lowest in the share of informal employment.

The correlation between income level and the share of informality is also not obvious (figure 3E.1) Rich states and union territories, such as Lakshadweep, also have a large share of informal firms and informal employment, implying that there are multiple causes of informality across India.

The analysis uses the subsample of firms with fewer than 10 employees in the UME survey to plot the distribution of informal firms by number of employees (figure 3E.2). The share of informal firms decreases as the number of employees in the firms grows. Among one-person establishments, 99 percent are informal. The share of informal firms drops to 96 percent, 88 percent, and 84 percent, respectively, among firms with two, three, or four employees. Among firms with more than five employees, informal firms only account for less than 80 percent of the firms.

The combined ASI and UME dataset shows that there are many more informal firms than formal firms (figure 3E.3). However, the typical informal firm is much smaller than the typical formal firm. Informal firms with only one or two workers account for more than 85 percent of all firms, but only generate 6 percent of the total output of firms.

The revenue produced by the average informal firm with more than three employees is Rs 14 million, which is 11 percent of the revenue of the average formal firm (figure 3E.4). The revenue of the average informal firms with fewer than or equal to three employees is only 1.3 percent of the revenue of the average formal firm. The average number of employees in formal firms, informal firms with more than three employees, and informal firms with fewer than three employees is 19.9, 4.8, and 1.3 employees, respectively.

Figure 3E.5 plots the size distribution of informal for example, firms with annual revenues of Rs 0–Rs 8 million. In the state of West Bengal, for example, firms with annual revenues above Rs 5 million are required to register with the tax authorities. If the owners of informal firms wish to keep their annual revenues below this level to avoid penalties, there should be bunching near the threshold. However, the number of informal firms with annual revenues near the threshold is not significant.