The Hindu Editorial Analysis- 28th January, 2022 | Current Affairs: Daily, Weekly & Monthly - CLAT PDF Download

1. India’s Economy and the Challenge of Informality: Policy Efforts to Formalise the Economy will have Limited Results as the Bulk of Informal Units are Petty Producers

Page 6/Editorial
GS 3- Economy

Context: Since 2016, the Government has made several efforts to formalise the economy. Currency demonetisation, introduction of the Goods and Services Tax (GST), digitalisation of financial transactions and enrolment of informal sector workers on numerous government Internet portals are all meant to encourage the formalisation of the economy.

Importance of Formalization

• The formal sector is more productive than the informal sector, and
• Formal workers have access to social security benefits.

Reasons for Informalization

• International Financial institutions like IMF that informal sector exists due to excessive state regulation of enterprises and labour which drives genuine economic activity outside the regulatory ambit. Arguably, excessive regulation and taxation ensure the endurance of informal activities.
• It is an outcome of structural and historical factors of economic backwardness.

Hence, From the Fiscal perspective it is believed that to increase formality what is required is:

• simplifying registration processes,
• easing rules for business conduct, and
• lowering the standards of protection of formal sector workers .

Approach taken by the government in this regard till now - Tax reforms: Early on, in an attempt to promote employment, India protected small enterprises engaged in labour intensive manufacturing by providing them with fiscal concessions and regulating large-scale industry by licensing.

• Such measures led to many labour-intensive industries getting diffused into the informal/unorganised sectors.
• Further, they led to the formation of dense output and labour market inter-linkages between the informal and formal sectors via sub-contracting and outsourcing arrangements (quite like in labour abundant Asian economies).
• Widening the tax net and reducing tax evasion are necessary.

Challenges to Dealing with the Situation from Fiscal side Alone

• Administrative challenge: Bringing the enterprises which benefited from the policy into the tax net has been a challenge.
• Political and economic reasons operating at the regional/local level in a competitive electoral democracy are responsible for this phenomenon, too.
• Sign of underdevelopment: A well-regarded study, ‘Informality and Development’ , argues that the persistence of informality is, in fact, a sign of underdevelopment. Across countries, the paper finds a negative association between informality (as measured by the share of self-employed in total workers) and per capita income. The finding suggests that informality decreases with economic growth, albeit slowly.
  • A similar association is also evident across major States in India, based on official PLFS data.
  • Hence, the persistence of a high share of informal employment in total employment seems nothing but a lack of adequate growth or continuation of underdevelopment.
• It has many layers: It needs to be appreciated that informality is now differentiated and multi-layered.
  • Industries thriving without paying taxes are only the tip of the informal sector’s iceberg.
  • Challenge of “petty production” - a the household level.
  • To conflate the two distinct segments of the informal sector would be a serious conceptual error. 
• The novel coronavirus pandemic has only exacerbated this challenge.
  • Research by the SBI recently reported the economy formalised rapidly during the pandemic year of 2020-21, with the informal sector’s GDP share shrinking to less than 20%, from about 50% a few years ago — close to the figure for developed countries. These findings of a sharp contraction of the informal sector during the pandemic year (2020-21) do not represent a sustained structural transformation of the low productive informal sector into a more productive formal sector.

Transformation in Asia

• The defining characteristic of economic development is a movement of low-productivity informal (traditional) sector workers to the formal or modern (or organised) sector — known as structural transformation.
• East Asia witnessed rapid structural change in the second half of the 20th century as poor agrarian economies rapidly industrialised, drawing labour from traditional agriculture.

Transformation In India

• However, in many parts of the developing world, including India, informality has reduced at a very sluggish pace, manifesting itself most visibly in urban squalor, poverty and (open and disguised) unemployment.
• Despite witnessing rapid economic growth over the last two decades, 90% of workers in India have remained informally employed, producing about half of GDP.
• India’s official definition (of formal jobs as those providing at least one social security benefit — such as EPF), the share of formal workers in India stood at 9.7% (47.5 million).
• Official PLFS data shows that 75% of informal workers are self-employed and casual wage workers with average earnings lower than regular salaried workers.
• Significantly, the prevalence of informal employment is also widespread in the non-agriculture sector. About half of informal workers are engaged in non-agriculture sectors which spread across urban and rural areas.

The Necessary Elements

• Policy efforts directed at bringing in the tip of the informal sector’s iceberg into the fold of formality by alleviating legal and regulatory hurdles are laudable.
• These initiatives fail to appreciate that the bulk of the informal units and their workers are essentially petty producers (self-employed and casual workers) eking their subsistence out of minimal resources. Therefore, these attempts will yield limited results.
• The continued dominance of informality defines under-development. Policy-induced restrictions are minor irritants, at best. The economy will get formalised when informal enterprises become more productive through greater capital investment and increased education and skills are imparted to its workers. A mere registration under numerous official portals will not ensure access to social security, considering the poor record of implementation of labour laws.

2. Understanding the Budget Formulation: How does the Budget affect economy and growth? In a pandemic year, is fiscal policy tuned to addressing contemporary challenges of unemployment and low output growth rate? 

Page/Text & Context  - I
GS 3- Government budgeting

Context: With the economy still hurting from the pandemic, the Budget on February 1 is likely to address concerns around growth, inflation and spending. The Budget, which will be tabled in Parliament by Finance Minister Nirmala Sitharaman, is the Government’s blueprint on expenditure, taxes it plans to levy, and other transactions which affect the economy and the lives of citizens. 

Major Components of the Budget

There are three major components — expenditure, receipts and deficit indicators. Depending on the manner in which they are defined, there can be many classifications and indicators of expenditure, receipts and deficits. 

The Expenditure Component

• Based on their impact on assets and liabilities, total expenditure can be divided into capital and revenue expenditure.
  • Capital expenditure is incurred with the purpose of increasing assets of a durable nature or of reducing recurring liabilities. For example,  expenditure incurred for constructing new schools or new hospitals, which is a creation of assets.
  • Revenue expenditure involves any expenditure that does not add to assets or reduce liabilities. Expenditure on the payment of wages and salaries, subsidies or interest payments would be typically classified as revenue expenditure. 
• Depending on the manner in which it affects different sectors, expenditure is also classified into:
  • General services
  • Economic services: It includes expenditure on transport, communication, rural development, agricultural and allied sectors. 
    • Social services: It includes education or health is categorised as social services.
    • Grants-in-aid and contribution.
• The sum of expenditure on economic and social services together form the development expenditure. 
• Again, depending on its effect on asset creation or liability reduction, development expenditure can be further classified as revenue and capital expenditure. 

The Receipts component: The receipts of the Government have three components — revenue receipts, non-debt capital receipts and debt-creating capital receipts.

• Revenue receipts involve receipts that are not associated with increase in liabilities and comprise revenue from taxes and non-tax sources.
• Non-debt receipts are part of capital receipts that do not generate additional liabilities. Recovery of loans and proceeds from disinvestments would be regarded as non-debt receipts since generating revenue from these sources does not directly increase liabilities, or future payment commitments.
• Debt-creating capital receipts are ones that involve higher liabilities and future payment commitments of the Government. 

Deficit Side

• Fiscal Deficit: it is the difference between total expenditure and the sum of revenue receipts and non-debt receipts. It indicates how much the Government is spending in net terms.
• Since positive fiscal deficits indicate the amount of expenditure over and above revenue and non-debt receipts, it needs to be financed by a debt-creating capital receipt.
• Primary deficit is the difference between fiscal deficit and interest payments.
• Revenue deficit is derived by deducting capital expenditure from fiscal deficits. 

Implications of the Budget on the Economy

• Generating Aggregate demand of an economy:  All Government expenditure generates aggregate demand in the economy since it involves purchase of private goods and services by the Government sector.
  • All tax and non-tax revenue reduces net income of the private sector and thereby leads to reduction in private and aggregate demand.
  • But except for exceptional circumstances, the GDP, revenue receipt and expenditure typically show a tendency to rise over time.
  • Thus, the trend in absolute value of expenditure and receipts in themselves has little use for meaningful analysis of the Budget. The trend in expenditures and revenue is analysed either by the GDP or as growth rates after accounting for the inflation rate. 
• Reduction in expenditure GDP ratio or increase in revenue receipt-GDP ratio indicates the Government’s policy to reduce aggregate demand and vice-versa. For similar reasons, reduction in fiscal deficit-GDP ratio and primary deficit-GDP ratios indicate Government policy of reducing demand and vice versa. 
• Implications for income distribution. For example -
  • Revenue expenditure such as employment guarantee schemes or food subsidies can directly boost the income of the poor.
  • Concession in corporate tax may directly and positively affect corporate incomes.
  • Though both a rise in expenditure for employment guarantee schemes or reduction in the corporate tax would widen the fiscal deficit, its implications for income distribution would be different. 

Fiscal Rules and How do they affect Policy

• Fiscal rules provide specific policy targets on the basis of which fiscal policy is formed. Policy targets can be met by using different policy instruments.
• There exists no unique fiscal rule that is applied to all countries. Rather, policy targets are sensitive to the nature of economic theory and depend on the specificity of an economy. 
• Recommendations of the N.K. Singh Committee Report. Allowing for some deviations under exceptional times, it has three policy targets — maintaining a specific level of debt-GDP ratio (stock target), fiscal deficit-GDP ratio (flow target) and revenue deficit-GDP ratio (composition target). 
• In India, it is primarily the expenditure which is adjusted to meet the fiscal rules at given tax-ratios. 
• Such an adjustment mechanism has at least two related, but analytically distinct, implications for fiscal policy.
  • Independent of the extent of expenditure needed to stimulate the economy or boost labour income, existing fiscal rules provide a cap on expenditure by imposing the three policy targets.
  • Under any situation when the debt-ratio or deficit ratio is greater than the targeted level, expenditure is adjusted in order to meet the policy targets.
  • By implication, independent of the state of the economy and the need for expansionary fiscal policy, existing policy targets may lead the Government to reduce expenditure. In the midst of the inadequacies of fiscal policy to address the contemporary challenges of unemployment and low output growth rate, the nature and objective of fiscal rules in India would have to be re-examined.