Dec 07, 2020 (LBO) – Around 70 percent of Sri Lanka’s workforce are informally employed and there are generally three reasons to be concerned about high informality: poverty, productivity and public finance, a new report says.
The World Bank in its report titled ‘Informality, Job Quality, and Welfare in Sri Lanka’ said that the quality of informal jobs is much lower than that of formal jobs.
“Informal workers have more precarious employment arrangements and inferior working conditions. Their low earnings levels elevate the risk of poverty,” the recently launched said.
The Sri Lanka labor force is segmented into three strands: (a) formal public sector workers who enjoy high remuneration, shorter work hours, many holidays, paid leave as well as other benefits, and overall job security; (b) formal private sector workers who make up a middle group, with access to social security and some paid leave but longer work hours and an earnings distribution that is closer to that of informal workers; and (c) informal workers, a group that includes informal employees as well as informal self-employed workers, most of whom are in precarious employment arrangements.
Few informal workers have a permanent contract or access to benefits, and they tend to work excessively long hours. There exists a persistent earnings gap between formal and informal workers, even when comparing workers of similar characteristics.
Moreover, the report says, the risk of extremely low pay and thus poverty is significantly higher for informal workers. However, it should be noted that the overall earnings distribution of formal private sector workers is much more similar to that of informal workers than that of public sector workers.
“Stringent labor laws, along with the high cost of compliance and complexity of labor regulations, have encouraged informality,”
“But formalization does not necessarily ease other constraints such as access to credit, reducing the incentive to formalize.”
The Termination of Employment of Workmen Act (TEWA), which regulates dismissal conditions and compensation, has been long criticized for making it difficult and expensive to dismiss employees.
In fact, Sri Lanka has the second-highest redundancy cost in the world. Gratuity payments, contributions to the Employees’ Provident Fund, Sri Lanka’s social security scheme, and the Employees’ Trust Fund, and generous paid leave and holidays add to the labor cost borne by the employer. Multiple and overlapping types of coverage for workers owing to different regulations create a complex operating environment for firms, making compliance costly.
As a result, compliance tends to be incomplete, even for larger firms. Enforcement is generally weak due to manpower shortages in enforcing agencies, and the many lines of enforcement render the existing institutions inefficient and ineffective, while the labor dispute settlement system can lead to lengthy and costly processes. Moreover, there appear to be few benefits to formalization.
The prevalence of the informal sector can be explained by a trade-off between firms’ costs for labor and capital: that is, informal firms have higher capital costs and lower labor productivity but can avoid certain labor costs associated with mandated taxes and benefits. But evidence suggests that while being informal likely precludes firms’ access to formal credit institutions, formalization itself does not guarantee easier access because of high collateral requirements and other bureaucratic procedures. This means that streamlining the business registration process alone will not suffice to decrease informality.
Rather than reducing informality itself, the focus of reforms should be on increasing productivity and job growth, the report recommends.
“Regulatory reforms that aim to reduce the cost and increase the benefits of formality would further encourage the creation of formal jobs.”
The following reform components are suggested in line with recommendations from around the world:
• Invest in human capital to promote productivity gains and reduce the wage gap.
• Increase flexibility in labor markets and quality of jobs by reducing labor taxes and streamlining regulations, which would support job creation more broadly.
• Build an adequate and effective social protection system.
A well-conceived formalization strategy would aim at increasing the benefits and reducing the cost of formalization through a policy mix that tackles the interrelated causes and consequences of informality together, ultimately leading to the creation of more and better jobs. This is based on evidence from other countries that found that formalization efforts focusing on easing entry regulations yielded limited success.
The imperative for Sri Lanka to implement these reforms is driven, among others, by the rapid aging of the labor force. The employment protection legislation that imposes a prohibitively high cost on the employer for dismissals of employees with long tenure encourages high turnover and early exit from the labor market.
The regulatory and incentive scheme needs to be restructured to encourage more working-age individuals to join and remain in the labor market productively.
This would help meet the labor demands in a country that still needs to grow significantly but is undergoing rapid aging.