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Mitigating Risks of Increasing Formalisation of the Indian Economy


One of the most talked about topics in the economics realm in India is the ongoing effort to formalize the informal sectors of the economy, bring everything into ship-shape and into the tax net; ensure registration, increase tax compliance and so on.  Let us consider the MSME sector and the informal sector. This employs the maximum people. You cannot call it an issue; you cannot just summarize non tax compliance as an issue and simply formalize. The thing is, the entire current structure as it exists - warts and all; performs a few functions :


1) First, it employs people. The concept of formalization will perforce lead to layoffs, and in the absence of proper handling will lead to massive social problems, and human problems.
2) Second, it is a supplier, vendor, customer etc of larger corporates and customers
3) The current system as it exists is a part of the overall competitive and cost structure and has extensive upstream and downstream dependencies


Image Source Pixabay


THE NEED OF THE HOUR

Need of the hour is to understand the overall structure industry-wise, not look at it piecemeal. We have to understand the cost structure, role/capability/functional competence and contribution of each layer of each industry, examine intra-industry dependencies and then formulate answers, responses and actions on the ground, such that risks that emanate from newer, admittedly superior strategy are understood and planned for. This ensures a smoother transition, and further ensures lesser roadblocks and much much lesser resistance to the new policies.

EXAMPLE
Ex - Stainless Steel. The intra-industrial dependencies of distributed small and large manufacturing, trading organizations has spread risk, while simultaneously reducing capability. The dependencies of the larger traders, even producers, who sub-contract tasks and jobs to small companies and jobbers is massive. Cost saving is built into the competitive structure. as are deep structural relationships. You remove one cog, the whole edifice collapses

Thus, while this structure is extraordinarily resilient to external and internal shocks, innovations, capability enhancements become hard; which is why you find special steels, steel quality etc as a manifest complaint issue, hampering the further development of the industry on the quality-value scale. Deeply forged interdependent ties make a system highly resistant to shocks. That is why the Indian  Market is so impenetrable for most outside companies
IMPACT OF FORMALISATION – ONE PARAMETER
If you formalize, you remove one cog- introducing cost-implications all along the channel. Unless you think of a workable strategy to counter this change, it leads to a collapse - this is pretty much exactly what happened since 2014-15. The introduction of compliance, formalization etc - while a decided plus, introduces deep systemic inefficiencies {to take but one functional example}, altering the cost structure - pricing out companies, leading to a collapse. The current revenue streams are irrevocably tied to the current methods. So, in this atmosphere, given the chance of a loss, people pull out; choking the channel all along the line....

IMPACT ON INDUSTRY STRUCTURE
Everyone is saying formalize. Fine. But, what about the current structure and revenue streams that are dependent on a calculation that does not account for these additional costs? Sure, benefits are certain - but in order that we encash on those pies in the skies, where are the attendant plans to ensure that the resultant shock waves from the alteration of the fundamental premise of an industrial vertical structure are mitigated? They don’t exist; ensuring certain failure of formalization attempts. The returns from GST are mute proof of that. You require structural reforms, painstakingly planned and executed with a focus not on big talk but on small incremental steps that engender systemic change, tackled on a war footing.

THE REHN PLAN
Look up the Rehn Plan : implemented successfully in Sweden. We can all learn from such examples. Or the Singaporean model, or many many others we can use for inspiration. We don’t need big talk; we need small changes with the big talk, or rather - we need both. New costs destroy the premise of previous investments, demand cycles, vendor relationships and POs, leading to loss of production and sales. It leads to job losses, layoffs; the beauty of the Rehn Plan was that such exigencies were actually catered to BEFORE the big talk was implemented,strategised and channeled into positive direction

WE NEED SELF PLANNED SOLUTIONS, NOT BLIND APING OF THE WEST
That is why I stated we need independent solutions. We cannot afford to talk big, implement big change without anticipating and mitigating redundancies in the factors of production that the new approach are sure to create {to put it in economic terms}. Most writers are talking big, and are right. But their approach is very theoretical and without catering to practical realities

We cannot compare India with other countries – each country has its own realities. One recent writer compared India with the USA among other nations, an  erroneous premise in its entirety. He also doesn’t address the critical HOW, as also what will happen to the millions who will be displaced.... something others have thought of, and successfully strategized, as indicated above. The US has 22 Mill Ent on a vastly different corporate and economic structure; vastly different demographics, and most critically, a population of barely 400 Mill. We have a pop of 1.3 Billion! Thus, we cannot compare; we can examine models, study them and draw inspiration, after ensuring local applicability basis solid fundamentals!

FACTORS OF PRODUCTION
There is no formalized structure to mitigate the people who get left out. Typical US style of development, hard hearted, impractical and theoretical. They represent a factor of production. Also, the new system will also create other factoral redundancies, unless properly mitigated. Waste of productive resources; also lead to internal resistance and hindrances in the change process. They also represent human beings, also factors of production and resources, also potent political movement in the wings if rankled.  And this is just one factor of production; similar studies and analyses needs to be done to identify redundancies and problems the new approach will create on all factors of production, and mitigated.

Productivity follows as a result of certain steps. Their productivity improvement {as referred to in some of the cases above} involved anticipating redundancies two years ahead, relocating and retraining manpower ahead of structural changes. We are doing the opposite. Formalizing without anticipating and reallocation of productive resources in line with the new direction, which is why we fail where others succeed! Without the other steps, this one sided approach will either fail or stall the economy in the short to midterm… can we afford that risk?

MITIGATING ATTENDANT RISKS
As you formalize, costs related to labour go up, rendering the structure uncompetitive, or introducing unacceptable risk {to the management that is}. That is what - exactly what- happened in Belgium. This is just one small parameter that needs consideration; it also upends existing agreements, cost structures, competitive balances, business relationships etc.  These are all risks that can be foreseen and negotiated – and are not meant to be seen from a right or wrong perspective. The current is the way it is, to change it, we need to mould the incumbent players in the industry, not force them.

Articles, authors and writers advocating formalization of the economy, introducing sea-changes are just talking big, without attending to mitigation or evolving a broader structure - which is what most experts, real researches documented in India, Belgium, Sweden, Sri Lanka, Brazil etc are saying with solid established documented data. Th. e key is factor reallocation planning and implementation BEFORE formalization.

The benefits of formalization of the Economy are not in debate; but in order that we can get the benefits of formalization, we need to plan for the resultant effects of formalization and strategize to minimize the escalating impact of the same - some researches present in the public domain prove that. We are just formalizing, leaving the rest to chance. The downside of the attempts to bring all informal sectors into the formal fold needs to be stated, planned for, strategized and implemented in order to mitigate the involved risk. We all of us want the benefit of formalization to be reaped; unless we plan for the downside, and mitigate risks, we won’t get there – or more likely delayed considerably, that is a real risk!

CONCLUSION
There can actually be no arguments against formalization, and bringing all informal economic activities such that all are regulated, pay taxes, are under the net; but does that mean we leave the risk mitigation to chance? Risk handling is fundamental to a working plan. Without risk mitigation planning, it isn’t a plan, but a statement of intent or at best a risky plan with no downside planning, no anticipation and no plan-b to cater to hiccups and roadblocks! Does that sound like a great plan? Not to me it doesn’t. And, basis what I have observed in India so far, I don’t see any risk mitigation planning. If one is present, I for one would love to read about it…

Note : Stay connected as I examine some models of development from history in the next few months on this page – The Rehn Plan, The Singapore Model of Housing as a means to develop, The Meiji Restoration of Japan in 1868 

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