Pakistan’s Informal Economy and Its Impact on Economic Growth

by Muhammad Shahzad
The size and characteristics of the informal economy vary widely across countries and regions, but it is estimated that around 61% of the world’s workforce is employed in the informal economy. This corresponds to approximately 2 billion people, according to the International Labour Organization (ILO). The size of the informal economy is generally higher in developing countries, where formal job opportunities may be limited and where regulations and enforcement mechanisms may be weaker. In Asia, for example, India’s informal economy is estimated to be 90% of the country’s workforce. China’s informal economy is estimated to be 30% of employment in the country. Women are also disproportionately represented in the informal economy, particularly in low-skilled and low-paid occupations such as domestic work, street vending, and small-scale manufacturing. According to the ILO, around 80% of domestic workers are employed informally. The COVID-19 pandemic has had a significant impact on the informal economy, particularly in sectors such as hospitality, retail, and construction. Lockdowns and other restrictions on economic activity have led to widespread job losses and reduced incomes for informal workers, many of whom lack access to social protections such as unemployment insurance or sick leave. Pakistan has a large informal economy that comprises nearly 80% of its employment. The informal sector includes small-scale agriculture, retail shops, street vendors, domestic workers, and various small enterprises. While the informal economy provides jobs and supports the livelihood of many, it also has some negative impacts on Pakistan’s economic growth. The informal economy does not pay taxes, resulting in a major loss of revenue for the government. This lack of funds reduces the government’s ability to invest in public services like education, healthcare, and infrastructure that are essential for economic growth. The informal sector has an unfair advantage over the formal sector as they do not have to pay taxes, follow regulations, or meet quality standards. This results in unfair competition that hinders the growth of formal businesses. Pakistan’s informal economy has a significant impact on the country’s economic growth. The informal economy is estimated to be 35.6% of Pakistan’s GDP, which represents approximately $661 billion at GDP PPP levels. The informal economy has a significant role in declining the formal sector of Pakistan’s economy, according to a study. More than 40% of Pakistan’s GDP comes from the informal sector, according to the Small and Medium Enterprise Development Authority (SMEDA). The informal economy in Pakistan is characterized by several decent work deficits and challenges, including rights at work, child and bonded labor, and social issues. The interaction of the informal sector with the formal economy in Pakistan has been explored in a study, which provides estimation results. The informal economy is largely unregulated and lacks enforcement of labor laws and standards. This leads to poor working conditions, low wages, and a lack of job security and benefits for workers. Such conditions reduce productivity and economic opportunity. To harness the potential benefits of the informal economy while mitigating its downsides, the government should take the following steps: Increase tax revenue The government must broaden the tax base by bringing more informal businesses and individuals into the tax net. This can be done by simplifying the tax code, reducing tax rates, and providing amnesty or incentives for those who register and pay taxes. Increased tax revenue will provide the government with more funds to invest in development and growth. Improve regulations Regulations on the informal sector should be strengthened and enforced to create a level playing field, improve working conditions, and boost productivity. However, regulations must not be too burdensome, or they will discourage businesses from joining the formal sector. A balanced approach is needed. Invest in skills training The government should invest in skills training and education for workers in the informal economy. This will help raise their productivity and income level, and facilitate their transition to formal employment. Vocational training programs tailored to the needs of informal sector workers can have a high impact. Facilitate access to finance Access to finance is crucial for businesses in the informal sector to grow and transition to formality. The government should work with microfinance organizations and banks to provide loans, credit, and other financial services to informal businesses and entrepreneurs on easy terms. This access to capital can help them expand and thrive. Improve infrastructure The government must invest in building and improving infrastructure like roads, electricity grids, water and sanitation systems, and internet connectivity. The better infrastructure reduces costs for businesses, helps them scale up, and boosts overall productivity and economic activity. It also makes the transition to formality more feasible. Pakistan’s informal economy is characterized by several decent work deficits, including limited access to labor welfare services, rights at work, child and bonded labor, social protection, lack of sustainable employment, working poverty, and gender-based discrimination. A majority of the poor in Pakistan are part of the informal economy, including home-based workers, domestic workers, sanitary workers, and care workers having no formal contractual arrangements. The informal economy has a significant role in declining the formal sector of Pakistan’s economy, according to a study. The size of Pakistan’s informal economy is estimated to be 35.6% of GDP, which represents approximately $661 billion at GDP PPP levels. The size of Pakistan’s informal economy is estimated to be as much as 56% of the country’s GDP, which means that it’s worth around $180 billion a year In conclusion, Pakistan’s large informal economy provides employment and income to many, but it also hampers economic growth due to a lack of taxes, unfair competition, and poor working conditions. The government should take steps to increase tax revenue, improve regulations, invest in skills training, increase access to finance, and improve infrastructure. These actions can help maximize the benefits of the informal sector while mitigating its negative impacts, thus facilitating greater economic prosperity in Pakistan.

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