Proper infrastructure must to get rid of inefficient informal sector

LAHORE: Informal economy is not only haunting Pakistan, but is an issue in most of the developing countries. The size distribution of firms in Pakistan has a long tail. A large number of small, unproductive or low productive firms coexist with a small number of large, productive firms.

From an economist’s point of view, this is highly inefficient. They argue that if small unproductive firms are closed down and the larger more productive firms hire their workers, it would not only increase productivity but also improve the well being of the workforce.

The small unproductive firms hire workers at 60 percent the minimum wage with no social security benefits available. The larger document firms not only pay the minimum wage but contribute to the state for their old age benefits and social security.

Logically, this should happen automatically as larger more productive firms should be able to deliver better quality products at lower prices. They should also have no problem in luring the workers by paying them 40 percent higher wages they get at smaller unproductive firms.

This, in fact has happened only in developed economies, but not in economies like Pakistan. Inefficient firms continue to survive trapping the available resources of the nation in low productivity activities. The continued survival of these firms does not make any economic sense.

For some it is the cumbersome government regulations that smaller firms cannot comply but even then the market forces should have come into play to throw them out of production. Others claim that tax evasion creates an unfair advantage for the informal firms. This opinion has some strength.

The sales tax on manufactured goods in Pakistan is generally very high at 17 percent of the retail value. Even the most efficient larger firms cannot operate successfully at a disadvantage of 17 percent.

Successive governments in Pakistan have been experimenting ways to bring small firms into tax net. Sales tax has been levied on power and utility bills, banks deduct 0.3 percent on withdrawals over Rs50,000 per day from non-filers. However, despite changing tax codes or redesigning the registration system nothing has worked.

The core issue in this regard is that of infrastructure. Let us take the case of a worker who gets Rs14,000 monthly salary in an organised sector firm located far away from his home and he gets Rs9,000 per month from a low productive firm situated in the neighbourhood he resides.

The usual commuting time to and from work in major cities is three hours per day, which costs Rs2,000-Rs3,000 per month. So a worker employed further from home spends 11 hours to earn Rs14,000, deduct on average Rs2,500 travelling expenses, and he takes home only Rs 11,500.

In 26 working days he spends 286 hours on job including commuting time. He gets Rs40.20 per hour in this monthly exercise. The worker earning Rs9,000 near home takes 30 minutes to walk to and from work and spends 8.5 hours per day.

He has no travelling expenses. In 26 working days he spends 221 hours outside home on job related activities. On his net income of Rs9,000 he earns Rs40.72 per hour, which is slightly higher than the wage earned by a formal worker without the hassle of working far away from his residence.

This is the reason that most workers prefer to do something useful near home rather than to work at better firms located far away. The informal sector flourishes because people are disconnected from modern production networks.

It is not possible to eliminate inefficiency simply by reducing the cost of registering a business or forcing small firms to pay taxes. Planners need to redesign urban space, including subways and dedicated bus lanes, with a more integrated approach to housing, social services, and production areas. In Pakistan Lahore is moving in that direction.