# 2. **Compliers, Evaders, Avoiders and Outsiders**

The Factories Act (1948) states that all enterprises in manufacturing who use electricity and have 10 workers or more, and all enterprises with 20 workers or more who do not use electricity, are required to register. Registered enterprises are referred to as the organized (“formal”) sector. Information about registered enterprises is gathered through the Annual Survey of Industries (ASI). Every five years the National Sample Survey Organisation (NSSO) conducts a survey of enterprises that are **not** registered under the Factories Act, in other words, of the “unorganized” sector. The survey collects a large amount of information on these enterprises, including the number of workers and electricity usage. It is possible, therefore, to analyze the extent and nature of noncompliance with the Factories Act using this information.

Although the “shorthand” characterization of the organized sector is often in terms of “10 workers or more”, as noted above the actual Act also has a differentiation between enterprises who do and who do not use electricity—for those who do not, the threshold is 20 workers or more. However, we argue in Appendix A that the electricity use criterion, important though it may have been in 1948, is increasingly irrelevant. In what follows we will define formality using just the “10 workers or more” criterion.

Given the two data sources, we can quantify the size of categories A, B, C and D. Category A firms are those that have registered under the Factory Act, which are to be found in the ASI data.<sup>7</sup> Category B firms are those in the NSSO survey who have 10 workers or more. These firms should have registered but have not done so. Category C presents a particular difficulty because it is based on a counterfactual—how exactly do enterprises adjust out of the regulation? However, we can argue as follows based on the theory of the previous section. If an enterprise would have had 10 workers or more without the regulation but now wishes to adjust out and come in “just below the radar”, then it would adjust down to just below 10— in other words, 9 workers. Thus the observed number of firms in the NSSO survey in the 9 worker category will give us an overestimate of Category C, since some of the 9 worker firms in the NSSO could be “naturally” of size 9 and will not have adjusted out of the regulation. There is then a corresponding underestimate of Category D. With these definitions, we now move to an examination of the levels and trends in the different categories of firms.

Table 1 presents the magnitudes and characteristics of groupings A, B, C and D for using the 2009-10 ASI and the 2010-11 NSSO surveys.<sup>8</sup> It is seen that the formal sector (A) accounts for 0.8% of all firms<sup>9</sup> and 24.8% of all manufacturing employment. The informal sector thus accounts for 75.2% of employment in this data. As between different types of informality, the evaders, (B), account for 91.5% and the avoiders (C) account for at most 0.4% of enterprises. The vast majority of enterprises, 97.3% are in category D—the “outsiders.” Further, the figure in Table 1 is an underestimate of this category since not all of those currently classified in category C are necessarily “avoiders.” The outsiders account for 64.1% of all employment, again an underestimate. Thus, the Factories Act directly affects firms that employ at most 35.9% of workers (categories A, B and C). Of the

> 7 Interestingly, and perhaps somewhat surprisingly, there are a significant number of firms in the ASI who have less than 10 workers— these firms do not need to be registered but are nevertheless registered. This phenomenon has been noted before, for example by Bedi and Banerjee (2007). One explanation for this might be that they were once registered but have not bothered to or managed to deregister, or are still erroneously being carried on the register. Characteristics of these firms are set out in Appendix B.

> 8 We use enterprise data from the ASI 2009-10 and the NSSO 2010-11 surveys. The survey period for the ASI was from October 2010 to April 2011 and for the NSSO from July 2010 to June 30 2011.

> 9 A factory unit is defined as firm here.

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