Stagnant manufacturing growth in India: The role of the informal economy

The growth of the manufacturing sector is important for overall productivity growth. Indeed, the rising importance of the manufacturing sector at early levels of development is considered one of the stylised facts of development. Recently, several developing countries have skipped this step however, with stagnant growth of the manufacturing sector. In this paper, we investigate the role of the informal segment in the stagnant growth of the manufacturing sector in the context of India. To do so, we initially compute the drag imposed by informality on the productivity growth of the manufacturing sector before investigating whether the movement of workers between the formal and informal segments of the manufacturing sector is having an impact on manufacturing productivity growth using a relatively long time series of data for the period 1980-2011. We find that the informal segment is harmful to the growth in productivity of the manufacturing sector. Using a modified shift-share analysis with the introduction of the informal segment, we find that labour reallocation to the informal segment of the manufacturing sector is growth reducing in the Indian manufacturing sector. The main source of this growth reduction is the within sub-sector structural change effect, indicating that workers move on average from productive formal to less productive informal employment within sub-sectors. In terms of movements across sub-sectors, there has been a movement towards more productive informal activities, but this has not been enough to offset the negative within sub-sector effect. Mainly, we have seen limited growth-reducing structural change after the 1994 liberalisation, implying that employment has moved to less productive informal firms after liberalisation.