Regulating the informal economy
In Pakistan, managing the unofficial economy presents a multitude of complicated issues. The lack of documentation and absence of adequate record-keeping constitutes one of the key obstacles.
This makes it hard for the government to maintain track of business activity, tax commercial enterprises fully, or enforce tax legislation. The inability of informal employees and enterprises to access conventional financial services commonly limits their capacity to expand operations, make profitable ones, and accumulate savings.
According to the Labor Force Survey 2020–21, the informal sector makes up 72.5 percent of major jobs in the non–agricultural sector.
More people work in the informal sector in rural areas (76.2 percent) than in urban areas (68.5 percent). Therefore, when one takes into account 43.5 percent of all employment, the informal (non-agricultural) sector is the largest contributor.
Tax evasion by informal employees and business enterprises prevents the government from funding public goods and services. In addition to deficient social security and legal protection, informal laborer are more susceptible to abuse and economic shocks.
For instance, according to the International Labor Organization (ILO), employees in Pakistan have little access to labor welfare services.
Pakistan’s regulatory framework is frequently complicated and onerous, which discourages informal establishments from switching to the formal economy.
Simplifying and streamlining taxation procedures can encourage businesses to register and conduct themselves lawfully. However, since they worry about higher expenses, more paperwork, and government meddling, informal firms may be resistant to regulation.
Pakistan needs a diversified strategy to successfully resolve challenges in regulating the informal economy. This strategy should include various important approaches.
For instance, the government’s investment in thorough data collection and analysis is a key step towards controlling the informal sector as it helps document the economy. Because accurate data may serve as the basis for regulating the informal economy.
Promoting financial inclusion is a crucial part of formalizing the informal economy. This entails implementing policies that provide undocumented workers and companies with access to financial services. Savings accounts, microcredit, and other financial instruments may be a crucial factor in promoting this inclusion.
Provision of access to formal financial services will incentivize workers and businesses in the informal sector to transition into the formal economy. This shift will not only enhance their financial stability but also contribute to the overall economic stability of the country.
To encourage informal businesses to voluntarily transition into the formal economy, simplifying tax procedures is essential. The complexity of existing tax procedures often dissuades informal enterprises from registering and operating legally. Therefore, the government should eliminate these obstacles and promote regularization by streamlining the tax system and offering incentives.
Improving social safety nets and labor safeguards is pivotal for enhancing the standard of living for informal employees.
Those working in the undocumented sector lack basic legal protections and social security benefits, making them vulnerable to exploitation and economic instability.
By strengthening these safety nets, we can enhance working conditions and alleviate the financial burdens faced by individuals in the unorganized sector.
Campaigns aimed at increasing public awareness are crucial for reshaping attitudes towards formalization within the informal sector. These initiatives can amplify the benefits of transitioning to the formal sector.
The government must publicize information and fix fallacies to encourage more informal workers and enterprises to view documentation as a practical and desirable alternative.
Several countries have successfully regulated their shadow economies through diverse instruments. For instance, Brazil has implemented measures such as credit cooperatives, a simplified tax system for small businesses, and regularization programs.
As per the study published in ‘Economía, sociedad y territorio’ (a research journal), the percentage of employees operating informally fell from 57.39 percent in 2002 to 44.38 percent in 2012 in Brazil, depicting a drop of 13.01 percentage points in just 10 years.
Similarly, Peru has introduced policies such as tax amnesty programs, microfinance organizations, and documentation initiatives.
According to an ILO study, in Peru, non-agricultural employment in informal sector reduced from 75 percent in 2004 to 68.6 percent in 2012. Mexico has also undertaken measures to regulate its unofficial economy by introducing tax amnesty programs, credit cooperatives, and documentation drives.
Legalizing the informal sector is a complex task that demands a holistic approach. To do this, we can use the strategies stated above as well as the lessons learned as well as best practices of countries around the world.
Nevertheless, it is of the utmost importance to modify these strategies to adapt to our specific settings, considering the fluctuating conditions of various informal economic sectors such as retail, construction, agriculture, and so on. Similarly, all informal employees and businesses must be considered in any government strategy.
It is critical to bear in mind that legalizing the unregulated sector of the economy is a long-term endeavor that will not yield rapid results.
The government, however, can make significant progress in formalizing the informal economy and realizing the consequent economic and social benefits through the implementation of a systematic and sustained approach.
This article was first published in the ‘Business Recorder’ on October 21, 2023.
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The writer is a Senior Pakistani Economist currently based in Saudi Arabia, holding a PhD in Economics with 18 years of diverse experience in research, analysis, and writing. Twitter Handle: @moheyuddin
