Difference between Formal and Informal Sectors in India

The economy of a country is one of the main elements of development. The economy consists of processes like the production, distribution, and consumption of goods and services. These processes are operated differently in different sectors of the economy, which can be named the “formal and informal sectors”

Formal and Informal Sectors examples

The functioning and operations of both the formal and informal sectors are different from each other in various aspects.

Formal and Informal Sectors – Definition

The “formal sector” is that sector of the economy where employment is registered and monitored by the government and is accountable for tax implementation of laws and its contribution to the economy of a country. Formal sector comprise of both government employment and employment in private enterprises.

Informal sector refers to the unregistered employment that people are involved in. Such employment is generally generated by people themselves in order to earn their living.

Formal and Informal Sectors – Examples

Government and private offices, banks, Public Sector Units (PSUs), Multinational Companies (MNCs), Trans National Companies (TNCs), etc. are a part of the formal sector.

Hawkers, vendors, artisans, landless laborers,  caretakers, maids, and servants, , activities like animal husbandry, tilling, carpentry,  nursery etc. fall under the informal sector.

Structure: Formal and Informal Sectors

The formal sector of the economy comprises of several roles and positions for the functioning of an office or organization where people holding different positions work collaboratively to meet the goals. These roles and positions are structured in terms of duties, qualifications and experiences.  Each role and position requires different criteria and people are appointed if they meet the prescribed criteria for the position. For example, an organization has the position of a manager, supervisor, project manager, advisor, team members, so on and so forth. Employment into each of these positions is possible only if the desired criteria for these positions is fulfilled. The status of each role is different and with improved performance and potential of the employees, they get promoted to the higher posts. In this manner, an organization or office is survived in a structured way.

In contrast, informal sector does not follow a structural organization. Works are assigned to the employees as per their abilities and performance. Also, informal sector has no facility of promotion to higher posts as in the formal sector. The workforce of the informal sector is less and the employees perform whatever task is allotted to them by the employer. 


People employed in the formal sector gets an assured and  fixed salary. The basic pay scale of the formal sector for each and every department is fixed and it doesn’t take into account the performance of the employees. However, incentives are given in accordance with the performance of the employees and sometimes they are provided with bonus during festivals or any other events. Salary in the formal sector usually remains high than the informal sector.

In the informal sector there is no such thing as a fixed salary. Payment is done solely on the basis of performance and profits earned from the employment. In this sector, if a person gets a heavy amount for his work in one month, he might not get the same amount in the next month. It depends on the employer when and how much to pay to the employees. Moreover, employees in the informal sector can participate in multiple tasks in different workplaces to earn more money. It depends on the employees how fast they are able to complete their multiple tasks and on the basis of that, they earn money.

Work environment

In the formal sector, employees work in an office or any other formal setting. The work environment  is bounded by rules and regulations that each and every employee is expected to follow. Work is performed on the basis of formal agreements, both in words and on paper, between the employer and the employees. Besides, there is also an expected dress code for the formal workers to adhere to. No casual or fancy outfits are appreciated during office hours, and not following the dress code is considered a violation of office ethics. It is the prevalent culture of the office or organization that creates the work environment in the formal sector. The office culture prescribes to the employees how they should present themselves in the workplace and how they are expected to conduct themselves while interacting with clients, customers, and even the employer and fellow employees.

In the informal sector, there is no hard and fast rule regarding the performance of assigned work, and the workers have the flexibility to perform as per their wishes and creativity, however, a quality outcome is expected. Exploitation of employees is seen in the informal sector, where working conditions are quite poor. Employees are expected to work long hours for a limited payment scale.  The informal sector has no official workplace or official agreements for the work to be performed. Regarding dress code, the informal sectors allow the workers to wear whatever they wish, as no strict dress code is followed. The work environment in the informal sector is quite frank and open, without any strict obligations. Also, there is no office culture to guide how one conducts oneself during working hours, and the interaction between people in an informal setting takes place in a natural flow without any formality.

Formal and Informal Sectors – Employment duration

The employment duration in the formal sector is fixed and lengthy. For instance, in a government office, an employee can work until he is 60 years old, after which he can retire from work. In other workplaces in the formal sector too, this is the practice. Job security is guaranteed in the formal sector, as the workers need not go job hunting after being employed in the formal sector, except under a few circumstances, like if any employee is fired due to reasons that violate the work ethics of the workplace or other such reasons.

In the informal sector, there is no fixed employment duration. It depends on the employer for how long he provides employment opportunities to his employees. For example, a painter could hire a few people to help him sell his articles at a fair, and after the fair, those employees could leave. Basically, the informal sector provides short term employment to people to meet certain goals; after the goal is achieved, there is no need for the services of those employees. The example of freelancers could be cited here, who are hired by people for a short term project in exchange for money, and after the completion of the project, they perform freelancing for someone else. The informal sector lacks the guarantee of job security because, even if at one point in time a person is employed, it is also possible that he might not land another job for some time and remain jobless.

Security Benefits

Employees in the formal sector get entitled to security benefits via workers’ associations or trade unions, where the grievances, needs, and demands of the employees are collectively placed in front of the employers so that improved terms and conditions of employment can be secured as well as improved status for the employees in the workplace. Labor laws are formulated for the protection of employees in the formal sector. Many offices in the formal sector also provide their employees with the facility of a pension after retirement for a secured future at old age, along with insurance for health and life issues.

In the informal sector, employees are not entitled to any kind of security benefits due to lack of structured organization and non-permanence of employees. Organizational democracy is absent in the informal sector as the employees are bound to work as per the instructions of the employers and also they are untouched by the benefits and protection of labour laws. Moreover, there is a lack of awareness among the employees of informal sector about their rights and privileges as they do not have the facility to be a part of workers association like the formal sector.  This sector provides no pension facility and the old age of the employees depends upon the life time savings they are able to make while working. The informal sector does not provide insurance on health and life as it is only concerned with the services its employees provide rather than anything else.

Social Relationships

In the formal sector, relationships between people is quite formal and is mostly revolved around work. The relationship between the employer and employees is limited to official work and a notion of status quo is attached to both. The employer is seen to have an upper hand in the work place and they keep in pouring instructions upon the employees.  Even the relationship between peers are formal in the workplace premise however a friendly or homely relation might be entertained outside the office.

The informal sector has no standardized relationship between employers  and employees and among peers. Communication takes place in an informal way. Informal sector too attach a status quo to the employer and employees but it is less rigid than the formal sector. The informal sector thrives on mutual respect for each other and their work irrespective of the position they hold.

Contribution to the economy – Formal and Informal Sectors

The formal sector is an active and direct contributor to the economy. This sector is regularized as well as monitored by the government and its agencies, and the activities of the formal sector are always scanned from time to time to make sure if the policies formulated for the smooth functioning of the economy are suitable or not. In such a case, the workload for the development of the economy is higher, and the assigned tasks are performed by the employers at a fast pace. The formal sector contributes to the GDP of a nation, and the employees of this sector are tax payers, which is why the formal sector is considered to be very important for the survival of the economy.  

The informal sector is a great platform for people with lesser educational qualifications, skills, and knowledge. These segments of the population are frequently excluded or denied job opportunities in the formal sector, but the informal sector employs them to earn a living by performing important but unrecognized economic work. It is noteworthy that not all the people belonging to the informal sector lack knowledge and skills as some become a part of this sector by choice to exercise their creative interests and earn a living all by themselves. The informal sector does not contribute to GDP and is not a tax payer, which is why they are not considered to be great contributors of a nation’s economy, but this sector has a role to play in the economy. The informal sector is as important as the formal sector, and both sectors have a kind of interdependence that remains unnoticed. For example, the manual labourers who belong to the informal sector work for the formal sector and contribute passively to the economy. However, it cannot be denied that if a country’s informal sector was more persistent, the development process would be much slower.

It can therefore be said that the economy cannot do without the prevalence and contribution of both the formal and informal sectors. Both sectors operate differently and have distinct characteristics; however, it is the interdependence of these two sectors that contributes to the smooth operation of the economy.

Also Read: Unemployment Problems and Reasons

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