Liberalization, Informal Sector and Formal-Informal Sectors’ Relationship: A Study of India

This paper shows how India initiated the process to integrate its domestic economy with the world economy from early 1990s due to severe balance of payments crisis, high fiscal deficit and high inflation rate. Since 1991 liberalization has exposed all industrial units including small home-based enterprises in the informal sector to the inherent risks of free market competition. Because of its wide coverage, the impact of economic liberalization is very significant on entire economy, or on both formal/organized and informal/unorganized sectors. How liberalization affects both the formal and informal sectors and what are the changing contributions of informal sector during pre and post liberalization periods in terms of income and employment are key researchable issues. The objective of this paper is to measure the relationship between economic liberalization and informal/ unorganized sector in India; and also measure the impact of formal and informal sectors’ linkages on the informal sector’s growth. The results show that as trade liberalization or country’s openness increases the size informal sector also increases in absolute terms, while the relative size of the informal sector decreases. Though organized sector is expanding in terms of its percentages share in Net Domestic Product, this growth is jobless. Our empirical findings show that the linkages between organized and unorganized manufacturing sector helps to grow the unorganized manufacturing sector.