Informality, Micro and Small Enterprises, and the 2016 Demonetisation Policy in India

• Author: Takashi Kurosaki
• Published date: 01 January 2019
• Date: 01 January 2019
• DOI: http://doi.org/10.1111/aepr.12245

Informality, Micro and Small Enterprises,

and the 2016 Demonetisation Policy in India

Takashi KUROSAKI†

Hitotsubashi University

Using a panel dataset collected in 2014–2017, we examine small and micro entrepreneurs in

Delhi, India, distinguishing registered (more formal) and unregistered (more informal) enter-

prises. The dataset contains not only information on the characteristics of entrepreneurs and

firms, but also General Social Survey trust information. Quantitative analysis comparing the two

types of entrepreneurs reveals that their social backgrounds and trust were different, and that

the difference is correlated with firm performance. In the micro and small enterprise sector in

Delhi, registered and unregistered firms coexist with different kinds of superiority, but the busi-

ness transactions of both types of firms remain highly cash-dependent even after the 2016

Demonetisation shock.

Key words: demonetisation, entrepreneurship, informal sector, innovation

JEL codes: O17, O14, L26

Accepted: 29 June 2018

1. Introduction

The informal sector is an important research topic in development economics. Accord-

ing to a survey by La Porta and Shleifer (2014), there are three major views toward

it. First, the informal sector is led by small businessmen with viable entrepreneurship

so that it has a high potential to grow if the government refrains from protecting

formal-sector firms. The second view, which is opposite to the first, characterizes the

informal sector as a parasite, dominated by low-productive entrepreneurs, who survive

because of their advantage of lower/no compliance with taxation and regulation. The

third view, which could lie between these two ones, is a dual economy view, in which

The author is grateful to Ashok Jain, S.N. Mishra, Asit Banerji, Kaushalesh Lal, A.K. Mangal,

Ramesh Kumar, Shampa Paul, and the staff of the Centre of Economic and Social Research for

data collection. The author thanks Jun Goto, Hironori Ishizaki, Yasuyuki Sawada, and Shunsuke

Tsuda for allowing him to use the dataset collected jointly and for their comments on the empir-

ical results discussed in this paper. He also thanks Asian Economic Policy Review Conference

participants, especially Hal Hill, Peter Morgan, and Hideki Esho, and Yuko Nikaido for their

detailed comments on an earlier version of this paper. Funding from a JSPS Grant-in-Aid for

Scientific Research (22223003) is gratefully acknowledged.

†Correspondence: Takashi Kurosaki, Institute of Economic Research, Hitotsubashi University,

2-1 Naka, Kunitachi, Tokyo 186-8603, Japan. Email: kurosaki@ier.hit-u.ac.jp.

© 2018 Japan Center for Economic Research 97

doi: 10.1111/aepr.12245 Asian Economic Policy Review (2019) 14, 97–118

the informal sector is segregated from the formal sector. Under this view, the informal

sector gradually dies out as poverty reduction proceeds. Using mainly the evidence

from World Bank Enterprise Surveys (WBES) across the globe, La Porta and Shleifer

(2014) favor the third view. They show that informal-sector entrepreneurs are less edu-

cated and less dynamic than entrepreneurs in the formal sector, informal-sector firms

are more isolated from modern financial services, and informal-sector firms do not

formalize much even when the cost of registration/formalization is reduced. La Porta

and Shleifer conclude that the lowly-educated, low-ability entrepreneurs are the key

factor distinguishing the informal sector from the formal sector. Based on this conclu-

sion, La Porta and Shleifer call for development policies to strengthen entrepreneurship

in small and micro enterprises.

1

Nevertheless, our understanding is highly limited regarding what characterizes

entrepreneurship in the informal sector and how to develop entrepreneurship out of

the sector. For example, does more education automatically improve entrepreneurs’

ability in the informal sector? What kind of training is effective in nurturing entrepre-

neurship?

2

As a first step toward answering these questions, this study characterizes

the informal-sector entrepreneurship in India using a primary dataset collected by the

author’s research group.

In India, where persistent absolute poverty and increasing inequality are becoming

serious concerns, micro, small, and medium enterprises (MSMEs) are attracting atten-

tion because they are perceived as labor-intensive, and labor-intensive industrial

growth is effective in reducing poverty. However, scientific evidence is limited with

respect to the coverage of sectors and different levels of informality, resulting in a lack

of deep understanding of what characterizes entrepreneurship in India’s MSMEs and

how to develop MSME entrepreneurship.

3

This study attempts to fill in these research gaps. It characterizes entrepreneurship

in micro and small enterprises in Delhi using a panel dataset compiled from primary

surveys covering both manufacturing-sector and service-sector firms and firms with

different levels of formality. The baseline survey conducted in November–December

2014 covered 506 micro and small enterprise businessmen, in which not only were the

characteristics of entrepreneurs and firms studied, but trust questions in the General

Social Survey (GSS) style were also addressed. In June–August 2017, the end line sur-

vey was conducted to collect panel information on firm performance. As the Demone-

tisation

4

policy in November 2016, in which high value banknotes were demonetized

overnight, affected small and micro enterprises substantially, specific questions on its

impact were added to the end line survey. The panel data provide us with valuable

information to investigate how small and micro entrepreneurs coped with the Demo-

netisation shock.

In this paper, these data are analyzed to address two questions: (i) what character-

izes more informal entrepreneurs/firms in comparison with more formal entrepre-

neurs/firms? (ii) what is the impact of being more formal on firms’performance

including coping with Demonetisation? In the first question, we assume that entrepre-

neurs evaluate the pros (benefits of policies that promote MSMEs) and cons (the costs

2016 Demonetisation Policy in India Takashi Kurosaki

98 © 2018 Japan Center for Economic Research