Premier University

Department of Economics

Assignment on
Financial System of Bangladesh (Informal Sector)

Course Code: ECO 476

Course Title: Security & Portfolio Analysis

SUBMITTED TO:

BADRUL HASAN AWAL

Assistant Professor

Premier University

Department of Economics

SUBMITTED BY:

Muhammad Shoaibur Rahman

ID: 1903010900578

Semester: 8th Batch: 30th

Premier University

Department of Economics
Introduction:

There is considerable debate about the role of the informal sector in an economy. There
are views that the expansion of the informal sector obstructs economic growth in the
developed as well as the developing countries as the informal sector may create a barrier
to increased productivity and economic growth. However, some contrasting views also
view the informal sector as a solution to poverty reduction and economic growth.

In Bangladesh, the informal sector constitutes a significant part of the economy and plays
an important role in employment creation, production, and income generation. The
informal sector also covers a wide range of economic activities resulting in the production
of goods and services, which makes a substantial contribution to the GDP. In Bangladesh,
48 percent of the workforce is engaged in the agricultural sector and if all the activities in
the informal sector are considered together, then the employment in the informal sector
turns out to be nearly 80 percent. Therefore, the informal sector is very important for the
Bangladesh economy, as its various channels have a major impact on both the formal
economy as well as the overall economy of the country.

The objective is to explore the linkages through which the informal sector in Bangladesh
affects the national economy in terms of growth, employment, and poverty reduction. It
builds a computable general equilibrium (CGE) model for the informal sector in Bangladesh.
This CGE model helps one understand the linkages between the formal and informal sectors.

THE INFORMAL SECTOR: ISSUES AND CONCERNS:

The informal sector has been defined in several ways in the literature. According to ILO
(1972), informality depends on a few characteristics such as the ease of entry, reliance on
indigenous resources, family ownership, small-scale operations, use of labour-intensive
and adaptive technology, unregulated and competitive markets, and skills acquired outside
of the formal sector. In 1993, the International Conference of Labour Statisticians (ICLS)
agreed to a unique statistical definition of the informal sector as including micro-
enterprises comprising informal employers, and hiring one or more employee(s) on a
continuing basis or family workers on an occasional basis.
In 2003, the seventeenth International Conference of Labour Statisticians (ICLS) amended
the definition of the informal sector, by taking into account certain types of informal wage
employment, and employment outside informal enterprises. According to the seventeenth
ICLS, “employees are considered to have informal jobs if their employment relationship
is, in law or in practice, not subject to labour legislation, income taxation, social protection
or entitlement to certain employment benefits (advance notice of dismissal, severances of
pay, paid annual or sick leave, etc)”. It appears that the informal economy is mostly defined
depending on the employment structure in an economy. Forms of informal employment
include agricultural day labourers urban street vendors, paid domestic workers, and at
home producers of clothing and other manufactured goods. Informal jobs mostly fall
outside the domain of the government’s labour market regulation. Moreover, informal
workers do not function with the types of legal protections concerning the number of
working hours, health and safety or with the types of mandated benefits that would
normally be a feature of formal employment opportunities in large, ongoing private sector
firms or in the public sector (Hussmanns, 2004). According to Chen (2004), the informal
economy comprises the informal sector plus other informal wage workers and industrial
workers, particularly industries that have no fixed contract with employees. In Bangladesh,
mainly two types of informal sector activities are evident, depending on the nature of the
job and the nature of the business. The nature of jobs focuses mainly on casual jobs,
temporary jobs, unpaid jobs, and subsistence agriculture, while sometimes this category
also includes multiple job holding. On the other hand, the nature of the business mainly
steers the illegality of business, that is, tax evasion, the avoidance of labour regulation,
and other government or institutional regulations, lack of registration for the company,
and underground activities, that is, activities which are not registered by statistical offices
like crime, taking of bribes, or corruption. The major characteristics of the informal sector
in Bangladesh are similar to those in the other developing countries and include: (i)
unregistered, small scale operation; (ii) low level of productivity; (iii) low level of income
generation; (iv) low level of institutional credit access (sometimes lack of access to formal
credit); (v) employment based mainly on kinship, personal/social relations, and casual
employment but mostly not on a contract basis; and (vi) generally the absence of
recognition or regulation by the government.
 ADB (2009) provided some estimates of the contribution of the informal sectors to the
GDP of Bangladesh (Table 1). It appears that agriculture, fishing, construction, wholesale
and retail trade, the real estate business and community services are predominantly
informal activities. Figure 1 calculates the shares of the formal and informal sectors in
sectoral GDPs. It is evident that, on the whole, the informal sector accounts for 63.6 per
cent of GDP. It is also estimated that 94.3 per cent of the agricultural activities are
informal. The corresponding figures for fishing, construction, wholesale and retail trade,
real estate business, and community services are 86 per cent, 71.4 per cent, 90.7 per cent,
93.8 per cent, and 90.7 per cent, respectively.

Table 1: A Rough Estimate of the Size of the Informal Sector as a Percent of the GDP

ISIC Sector Total share to Share to GDP (%)

GDP (%) Formal Informal
1 Agriculture 16.65 0.94 15.71
2 Fishing 4.71 0.66 4.05
3 Mining and quarrying 1.20 0.75 0.45
4 Manufacturing 17.65 11.88 5.77
5 Electricity, gas and water supply 1.60 1.51 0.10
6 Construction 9.23 2.64 6.59
7 Wholesale and retail trade 14.24 1.32 12.92
8 Hotels and restaurants 0.70 0.47 0.23
9 Transport, storage and communication 9.93 6.98 2.95
10 Financial intermediation 1.71 1.60 0.10
11 Real estate, renting and business activities 7.62 0.47 7.15
12 Public administration and defence 2.81 2.64 0.17
ISIC Sector
13 Education 2.51 1.98 0.53
14 Health and social works 2.31 1.89 0.42
15 Community, social and personal services 7.12 0.66 6.46
Total 100.00 36.40 63.60
Source: ADB (2009).
Figure 1: Shares of Formal and Informal Sectors in Sectoral GDP
6.0

6.0

6.0

18.2
21.0
29.7
32.7

32.8
37.3

63.6
71.4
86.0

90.7

90.7
93.8
94.3

94.0

94.0

94.0

81.8
79.0
70.3
67.3

67.2
62.7

36.4

Informal
Formal
 Figure 2: Sectoral share of informal sector in terms of employed persons aged 15 and over

8.01

8.81

9.97

21.56
21.65

28.29

28.64
33.24

43.72

46.86
50.98

63.54
77.63

91.19
92.50

94.22
91.98

91.19

90.03

78.44
78.35

71.68

71.32
66.76

56.28

52.72
49.02

36.46
Source: LFS (2005).

INFORMAL SECTOR AND GROWTH AND POVERTY IN BANGLADESH:

The CGE models capture detailed accounts of the circular flows of receipts and outlays in
an economy. They satisfy the general equilibrium conditions in the market simultaneously.
Such models are useful for analysing the associations between various agents of the
economy. In line with most of the CGE models, the model has been solved in comparative
static mode and provides an instrument for controlled policy simulations and experiments.
The solution of each simulation presents complete sets of socio-economic, meso and
macro level indicators such as activity/commodity prices, household incomes and
expenditures, factor demand and supplies, gross domestic products (GDPs), exports and
imports, and the household poverty situation. The model is calibrated to the SAM to
exactly reproduce the base year values. Households earn their income from production
factors. They also receive dividends, intra- household transfers, government transfers, and
remittances. They pay direct income tax to the government. Household savings constitute
a fixed proportion of the total disposable income. Household demand is derived from a C-
D utility function. There is one representative firm, which earns capital income, pays
dividends to households and foreigners, and pays direct income taxes to the government.
 It is assumed that foreign and domestic goods are imperfect substitutes. This geographical
differentiation is introduced by the standard Armington assumption with a CES function
between imports and domestic goods. On the supply side, producers make an
optimal distribution of their production between exports and domestic sales according to a
constant elasticity of transformation (CET) function. Furthermore, a finite elasticity export
demand function is assumed. It is assumed that foreign demand for Bangladeshi exports is
less than infinite. In order to increase their exports, local producers must decrease their
free on board (FOB) prices. The government receives direct tax revenue from households
and firms, and indirect tax revenue on domestic and imported goods. Its expenditure is
allocated between the consumption of goods and services (including public wages) and
transfers.

SIMULATION AND SIMULATION RESULTS:

It has been mentioned in Section II that there are contrasting views over the linkages between
the formal and informal sectors in the economy. The macroeconomic effects of the scenario of
a 10 per cent rise in investment in the formal industrial sectors are reported in Table 5. It
appears that such a scenario would result in a rise in the formal sector GDP by 1.25 per cent.
Because of the linkage effects, as mentioned in Figure 3, the informal sector GDP would also
rise by 0.72 per cent. The total real GDP would rise by 0.93 per cent. Such a scenario would a
have positive impact on the aggregate household welfare, which would rise by 0.46 per cent.
Both exports and imports would experience growth and would rise by 2.53 and 1.1.2 per cent,
respectively. The consumer price index would also rise by 1.31 per cent. However, returns to
factors (both skilled and unskilled labour and capita) would register a rise more than the rise in
the consumer price index, suggesting a rise in the real income of the households.

Table 5: Macroeconomic Effects

% Change from the
Variable
Base Year Value
Real GDP 0.93
Formal Sector GDP 1.25
Informal sector GDP 0.72
Welfare 0.46
Exports 2.53
Imports 1.12
Consumer Price Index 1.31

Return to unskilled labour 1.66

Return to skilled labour 1.56
Return to capital 1.47
It is, however, important to note that though in absolute terms, the informal sector expands,
in relative terms, such a scenario would result in the contraction of the informal sector as the
formal sector expands at a higher rate than the informal sector.The detailed sectoral price
and volume effects of the simulation are reported in Annex 1. Summaries of the sectoral
effects are presented in Figures 4 and 5. It appears that because of a rise in investment in the
formal industrial sector, the value-added price (PV) in this sector would rise by more than 1
per cent. Also, the domestic price (PD) and produce price (PX) would rise by 0.5 per cent
and 0.7 per cent, respectively. The value-added price, domestic price, and producer price in
the formal agriculture and services sectors would also rise. It is also evident that because of
the linkage effects, these prices in the informal industrial, agriculture, and services sectors
would also rise. However, the rises in the prices in the informal sectors are lower than those
in the formal sectors.

Figure 4: Percentage Change in Sectoral Prices from the Base run

Source: Simulation results.

Note: PD=Domestic goods price, PV=Value-added price, PX=Aggregate output price.

Figure 5 suggests that production in the formal industrial sectors would rise by around 1.5 per
cent. Because of the rise in production, there is a demand for increased imported inputs, which
results in a rise in imports in the formal industrial sectors. The export and domestic demands
in the formal industrial sector also rise quite significantly because of increased investment into
this sector. The formal agricultural and services sectors would also experience expansion. On
the other hand, the informal industrial, agricultural and services sectors would expand because
of the linkage effects mentioned above. The expansion of the informal sector relative to the
formal sector is the highest in the case of agriculture. This is because of the increased demand
for raw materials and final goods from agriculture (which is predominantly informal).
 Figure 5: Percentage Change in Volumes from the Base-run

Source: Simulation results.

Note: M=Imports, X=Domestic Output, E=Exports, D=Domestic Sales.

A decomposition of the growth in the informal sector is presented in Table 6. It appears that
the growth in the informal sector is mostly driven by increased household demand, which
accounts for 54.17 per cent of the rise in the informal sector GDP. The increased demand for
intermediate input consumption accounts for 40.28 per cent of the growth in informal GDP.
The rise in export demand accounts for only 5.55 per cent.

CONCLUSION:

There is no denying the fact that the information sectors are very important economic
activities in Bangladesh economy as they constitute significant shares in national income
and employment. There are considerable debates in economic literature with regard to the
contribution of informal sectors in economic growth as well as their links with the formal
economy. There are arguments that expansion of the informal sectors may dampen
economic growth at the cost of formal sector, whereas counter-arguments indicate the
possibility of acceleration of economic growth and expansion of formal sectors together
with the enlargement of the informal sectors. This paper uses a CGE model for the
Bangladesh economy with the aim of exploring the linkages between formal and informal
sectors. The simulation results suggest that a growth in the formal sectors would also result
in a growth in the informal sectors. There are also positive impacts on household welfare
and poverty. The major factors that lead to the growth in the informal sector are the rise in
household demand for informal sector goods and services as well as rise in demand for
intermediate inputs. These result in expansion of the informal sector in absolute terms.
However, in relative terms, informal sectors would contract, as the formal sectors expand
at a higher rate than the informal sector.
References:

ADB (2009), “Informal Employment in Bangladesh”, ADB Economics Working

Paper Series, No 155, Manila.

Becker, K. (2004), “The Informal Economy: Fact Finding Study” SIDA, Stockholm.

Chen, M.A., (2004), “Rethinking the Informal Economy: Linkages with the Formal
Economy and the Formal Regulatory Environment”, Paper presented at the
EDGI-WIDER Conference titled ‘Unleashing Human Capital: Linking
the Informal and Formal Sectors’, Helsinki, Finland, September
17-18,Available at
http://www.wider.unu.edu/conference/conference-2004-2/conference2004-2-
papers/Chen.pdf.