Pakistan’s undocumented economy: Benefit or burden in the face of natural disasters?

While there are downsides to having a largely undocumented economy, it does afford Pakistan the flexibility to recover quickly in the wake of a natural disaster.
Published September 23, 2022 Updated September 23, 2022 12:03pm

In recent times, the world has witnessed a plethora of unprecedented events that have potentially disrupted the traditional workings of the economy. The most significant among these was the Covid-19 pandemic that left nation states around the world struggling for economic rejuvenation.

Such occurrences tend to adversely impact the economy by causing widespread unemployment, incapacitating daily wagers the most. However, during the course of the pandemic, Pakistan exhibited unmatched resilience in terms of employment.

The Labour Force Survey (LFS) shows that the unemployment rate stood at 6.9 per cent in 2018-19, before falling to 6.3pc in 2020-21. According to The Economist, Pakistan ranked first on the global normalcy index [a score of the country’s return to normalcy following Covid-19 lockdowns] in November 2020 and ranked second in January 2021.

Another matter of grave concern of late has been climate change, which is threatening South Asian economies more adversely than others. Pakistan has witnessed a dramatic increase in climate disasters over the last few years, including but not limited to locust attacks, droughts, floods and heat waves.

Natural disasters, including pandemics, have a tendency to impact the most vulnerable segments of society most severely. In the case of Pakistan, the segment most susceptible to economic hardships is that employed in the informal sector due to the absence of job security, income stability, medical insurance, and other non-wage benefits.

The proportion of Pakistan’s informal sector has remained consistently above 70pc of total employment for over a decade. This undocumented sector of any economy is generally associated with lost tax revenues, unfair competition, low productivity, labour rights abuses, and environmental degradation. However, one cannot overlook the potential for innovation, entrepreneurship, flexibility, and resilience that characterises this very sector.

The analysis presented here focuses on the impact of recent natural events on employment, particularly in Pakistan’s informal sector, by comparing employment levels during 2018-19 and 2020-21.

We shall see if formal and informal employment have grown over time, shrunk, or remained stagnant. We shall further analyse the impact of these events on marginalised groups [non-male, have migrated recently (up to 3 years), are differently abled or belong to indigenous groups] within the economy. We shall also probe the potential causes of the changes, if any, and see how government policies have attempted to mitigate the adverse effects.

A story of remarkable resilience

Pakistan’s economy is predominantly comprised of the informal sector, which remains largely undocumented. This is problematic as it results in inaccurate estimation of the GDP, meagre tax collection and a lack of data to provide targeted subsidies, among other issues.

However, having a large informal sector can also provide economies the margin to absorb large-scale disruptions, such as those caused by recent natural disasters. While employment can go down in the short run, the informal nature of enterprises affords employers the opportunity to adapt to changing circumstances and re-hire workers as and when the economy starts to recover.

In this section, we will try to determine whether the informality of the labour market acted as a burden or benefit during the Covid-19 pandemic. We shall further see if the resilience, or the V-shaped recovery, demonstrated by Pakistan’s economy in terms of employment, can be attributed to the flexibility granted by the informal sector.

Initial reports on the impact of Covid-19 on employment suggest that the informal sector was at the front lines of the economic crisis and daily wagers were the first ones to be let go from work, losing access to incomes. The LFS 2020-21 shows that of all the individuals that lost access to work during the time of survey, 54.1pc were unable to work due to Covid-19. The pandemic also accounted for 18.53pc of underemployment during 2020-21.

It is important to note, however, that 56.8pc of all persons that were unable to work at the time of the survey reported that they would return to work once Covid-19 restrictions were lifted. To see if this impact was, in fact, short-lived, we delved deeper into the numbers. As the pandemic was expected to hurt informal and marginalised workers the most, we specifically looked at changes in employment numbers for these two sectors.

Using the Labor Force Survey, we estimate that the informal sector stood at 86.3pc in 2018-19, and at 86.8pc in 2020-21. Using account-keeping as a proxy for formal employment, we estimate that informal employment in non-primary sectors [other than agriculture, forestry and fishing, mining, and extraction of oil and gas] fell from 70pc in 2018-19 to 66.7pc in 2020-21.

Overall, informal employment increased across every dimension. Between 2018-19 and 2020-21, the proportion of daily wagers increased from 7.3pc to 8.8pc; the proportion of people employed without a contract or on temporary basis increased from 28.2pc to 32.3pc; and the percentage of persons working from an informal workplace increased from 62.2pc to 64.6pc, respectively.

This shows that regardless of the criteria used, the proportion of informal employment as compared to formal employment has increased overall. If total informal employment has increased, it would be correct to assume that the fall in informal employment in non-primary sectors suggests that informal employment in agriculture, fishing, and forestry has risen over the last few years.

Given that the total unemployment rate for Pakistan also fell during this time, these numbers present a story of remarkable resilience and perseverance. Not only were lost jobs recovered, new jobs were created during this period as well.

In April 2022, it was reported that the government created over 5.5 million jobs over the last three years through policy interventions. Most of these new jobs were created in the textile and construction industries, which potentially explains the increase in formal employment in non-primary sectors.

Furthermore, measures were taken by the government to attempt to formalise micro, small, and medium enterprises by incentivising them to register. According to the new SME policy, it was promised that banks would provide collateral-free loans of Rs10m each to 30,000 new SMEs at a concessional interest rate of 9pc with hassle-free registration.

While Covid-19 was expected to have disastrous impacts on the informal sector, we notice that there have not been any structural changes in the informal workforce. In 2019-20, agriculture and small-scale industries in the informal sector reported growth as opposed to the formal sector, which was faced with contraction in their revenues.

Due to job and income insecurity, informal workers in developing countries have adopted strategies as a coping mechanism, whereby they acquire a multitude of skills so they can switch jobs when needed; also, they distribute household members in different jobs to diversify risk.

Furthermore, small, informal businesses have little capital and minimal fixed costs which allow these companies to switch their nature or scope of activity depending on economic circumstances.

With the onset of Covid-19 and the resultant lockdowns, many individuals in the informal sector resorted to these strategies to minimise their losses, often violating laws.

The adaptability and resilience of different sectors is difficult to measure due to its subjectivity. However, it plays an important role in explaining the regional variations in economic performance observed post-crises — Covid-19 in the current scenario.

Informal sector and inclusivity during Covid-19

In most economies, the informal sector is dominated by marginalised communities. To estimate the impact of the pandemic on marginalised communities in Pakistan, we attempted to see what proportion of informal employment is accounted for by the marginalised labour before and after the pandemic.

We estimate that the marginalised groups accounted for 26.5pc of total informal employment in 2018-19, and for 25.6pc of total informal employment in 2020-21. Meanwhile, migrant representation in the informal sector fell from 2.6pc to 1.6pc.

Overall, female unemployment decreased from 10pc in 2018-19 to 8.9pc in 2020-21. Despite this, female employment as a proportion of total employment has barely risen from 22.2pc in 2018-19 to 22.5pc in 2020-21, hinting toward significant gender disparity along the ‘Economic Participation’ dimension.

Females remain majorly over-represented in the informal sector with 94pc of all employed women engaged in undocumented businesses. This proportion has persisted at this formidable level over the last few years. Of the 20 million home-based workers employed in the informal sector, 12 million are female with no legal protection.

Despite increases in total female employment, the constant rate of female employment in the informal sector implies that female representation in the formal sector has improved.

This can be attributed to the special feature of the new SME policy which provides 25pc tax rebate to female-led SMEs in addition to all the other facilities pledged under the policy.

Furthermore, the rapid digitalisation that was inadvertently facilitated by the lockdowns during the pandemic had resulted in a more inclusive environment. Females that were previously incapacitated in their ability to access work due to immobility are no longer constrained as hybrid and work from home (WFH) models provide them the flexibility to operate from home.

Climate change and informal sector

Climate change is one of the most pressing issues faced by economies around the world today. The threat of natural disasters occurring on a regular basis and disrupting the way of life presents itself as a major challenge across South Asia.

Research indicates that Pakistan ranks amongst the top ten countries most vulnerable to climate change.

Recently, Pakistan has faced an unprecedented number of natural disasters ranging from rising temperatures, floods, droughts, melting glaciers, heat waves, changing rainfall and snowfall patterns, wildfires, landslides, and locust attacks.

Among other issues, these climatic disasters are contributing to major problems for the informal labor force. Given the eclectic nature of climatic disasters that have impacted the country recently, informal employment in a broad array of sectors has been suffering, particularly in agriculture and livestock farming, among others.

In August 2020, torrential rains in the capital of Pakistan led to wide-scale disruption as thousands of properties, including workplaces, were uprooted, impacting nearly 2.4m individuals. LFS 2020-21 shows that bad weather conditions account for 3.45pc of underemployment in Pakistan. Also, at the time of the survey, out of all the persons that had lost access to work, 1.3pc were unable to work due to bad weather conditions.

Extreme weather events resulting in loss of income and livelihoods, or reduction of opportunities, can fuel labour migration as an adaptation strategy. Drought-like conditions, which began in late 2018 and continued through 2019, affected nearly five million people in Pakistan. Moreover, melting glaciers and the shifting monsoon season resulted in irregular access to water, damaging agricultural output on most farmlands and forcing cultivators to migrate to areas with favourable conditions.

Millions of people involved in livestock farming in the mountainous regions of Pakistan also had to bear the brunt of climate change as pastures were destroyed, forcing farmers to relocate. LFS 2020-21 shows that natural disasters accounted for approximately 0.3pc of migrations during 2020-21.

It is interesting to note that for the first time, natural disasters have emerged as a notable reason for migration of workers in the LFS 2020-21. Unregulated migration poses the danger of exposing workers to forced labour and other forms of exploitation, especially in the informal sector, which is prone to precarious working conditions and labour rights violations.

Between 2018-2019 and 2020-21, the number of injuries at work due to improper ventilation has increased by 130pc. Most of these injuries were sustained in the informal sector as most employers fail to provide safe and adequate working conditions to their workers.

With soaring temperatures each year, this number is bound to increase exponentially. Rising temperatures not only create unfavourable working conditions, but also reduce productivity significantly as heat stress reduces the ability of workers to perform tasks during the hottest hours. Despite having policies such as ‘The Punjab Labor Policy 2018’ which promises implementation of labour standards, improvements in workplace safety, and excellence in labour inspections regime, conditions remain inadequate as there is a serious lack of follow through.

This paints a picture of despondency as the threat to the informal economy from climate change looms larger than ever before.

But how do we protect a sector from a disaster it itself contributed toward? Research shows that the informal sector is a major contributor to climate change.

In recent years, noticeable deterioration in air quality in most parts of Pakistan can be linked to climate change, which is being exacerbated to some extent by the informal sector. Growing amounts of CO2 emissions and greenhouse gas emissions (GHGs) are being created by informal workers as a result of seasonal crop burning.

Moreover, the informal economy is most often dependent upon natural resources for their livelihood. As environmental regulations largely apply to formal sectors only, the informal sector continues to exploit natural resources, contributing to climate change.

The only note-worthy project initiated by the PTI during its tenure to counter climate change was the ‘Ten Billion Trees Tsunami Programme’, under which the government vowed to plant ten billion trees across the country. While the project is an effective tool to combat climate change in the long run, some immediate measures need to be taken to curb the negative effects on the environment by informal workers.

Given that climatic disasters are only expected to intensify in coming years, the government must take steps to regulate the informal economy to slow down the process of climate change.

Policy recommendations

There has been much debate about the general benefits and burdens of the informal economy. The most crucial is the humanitarian aspect of the debate which focuses on the exploitation of workers by employers that fail to provide adequate working conditions.

However, to date, the focus of the government has primarily been on regularising the informal sector to bring more people and businesses into the tax net, which is perhaps the reason why most individuals are hesitant to register their businesses.

Therefore, to effectively formalise the economy, the government needs to shift its focus on creating opportunities for innovation and entrepreneurship. With a significant youth bulge to capitalise on, there is a huge margin for starting new ventures abuzz with innovation.

The government must try to create incentives for businesses by promising them support rather than taxing them, thereby encouraging them to create solutions for the very problems potentially created by the informal economy.

The focus should be on inclusive development by creating equal opportunities for all and raising the overall standard of living for workers. In this regard, the new SME policy is a step in the right direction.

During its tenure, the PTI made vigorous attempts to formalise the economy, raising the number of registered taxpayers to a record 2.7m. However, tax collection remained meagre as there was much resistance from groups that did not want to be dragged into the tax net. There is genuine lack of trust toward the government fuelled by allegations of corruption, red-tapism, and mismanagement.

The general perception is that the government merely wants a piece of the pie. Formalisation of the economy should be aimed at furthering sustainable development goals by enforcing labour rights, environmental protection laws, and inclusivity. In order to achieve the desired results and to ensure significant increases in formal employment, further measures are needed to ease the process of registration and to make sure these reforms are made more public.

The government recognises that the Technical and Vocational Education and Training (TVET) programme is crucial for technology-driven, skill-based economic development, which is why it has developed training centres across Pakistan.

However, the problem lies with enrolment which stands quite low. Most young individuals opt for apprenticeships, otherwise known as the “ustad-shagird” system. Among the individuals that enrol in TVET programmes, gender stereotyping remains a chronic issue as most women are enrolled in “gender-appropriate” trainings, such as beautician courses, cooking courses, etc.

One cannot emphasise enough the need for just and inclusive human development, which in turn can only be achieved if equal work and education opportunities are promised for all. Diversity in the profile of entrepreneurs can lead to development of new products and services by promoting innovation and economic diversification .

Most importantly, there is a need to improve physical working conditions for all workers by ensuring that all businesses, formal or informal, conform to ILO standards in terms of providing safe and adequate working conditions.

Employers need to be held accountable for occupational injuries even if they are sustained in the informal sector. Moreover, informal employees also need to be brought into the social security net. This can be done by providing targeted subsidies.

In this regard, the newly introduced RAAST instant payment system is a great initiative as it will formalise the economy to a huge extent without making subscribers liable to tax regulation. The government can use the data it gathers in the process to provide targeted subsidies to the most deserving segments of the economy.

Conclusion

While there are many downsides to having a largely undocumented economy, the flexibility that characterises it is potentially the reason why Pakistan was able to demonstrate such elasticity in the face of the pandemic.

The lack of contracts in the informal sector grant employers the liberty and flexibility they need to adjust wages and number of employees during economic shocks. This potentially explains the reason behind the relatively stagnant unemployment rates in Pakistan. Thus, the informal sector had a key part to play in the swift recovery demonstrated by the employment graph during the pandemic.

However, we cannot rely on this flexibility to deal with all natural disasters. While the informal sector was effective in buffering the negative impact of the pandemic, we need to be cognisant of the fact that the informal sector is not just a victim to climatic disasters, it is also a contributor.

Therefore, the government needs to act in accordance and take initiatives to bring structure to the informal economy. Otherwise, the time is not far when this informal sector will need relief from the very calamities it facilitated.


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