The Informal Sector

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	Hari Srinivas
	One-Pager Series E-069. March 2015.

The emergence and persistence of urban informal sectors in developing economies challenge many of Lewis's core premises. By examining these deviations, we can better understand the informal sector's role as a structural response to the limitations of formal sector growth.

The "dual-sector" model is a model in development economics, which explains the growth of a developing economy in terms of a labour transition between two sectors, the capitalist sector and the subsistence sector [Wikipedia].

Aurther Lewis propounded his 'unlimited labour supply' theory by initially identifying the existence of two sectors in a national economy - the rural-based agricultural sector, and the urban-based industrial sector. Lewis postulated that there is a large 'reserve army' of labour in unlimited supply in the rural areas and this could be used to bring about economic development by using the labour in the industrial sector.

The various stages of the Lewis Model, as his postulate came to be known, and its relevance to the urban informal sector concept is compared below.

Lewis visualized the rural sector as a source of 'unlimited supply' of labour which could be tapped for the development of the industrial sector. He recommended increasing the urban wages slightly more than the rural wages so that this becomes attractive for the people living in the rural areas to migrate to the urban area and be absorbed into the industrial sector.

Lewis made the following assumptions to justify his model:

1.  ... that the level of industrial growth and urbanization is more than that of the population.

This has not been so. In fact, population growth (Lewis assumed one percent urban growth) has far exceeded the industrial growth in less developed countries. The very fact of the existence of an 'informal sector' is justification in this direction.

2.  ... that the rate of migration from the rural to the urban area will equal that of the number of jobs generated by the formal sector.

But the rate of migration (due to both 'push' as well as 'pull' factors) has far exceeded the expectation of the Lewis Model. The Todaro Model throws some light on this: (1) rural populations migrate to the city on the expectation or probability of a job and the urban informal sector has helped to 'absorb' these expectations; (2) creation of one job in the formal sector actually attracts more than one migrant and so the urban informal sector has been able to generate employment for them by using labour-intensive technologies (though not for this reason alone)

3.  ... that the level of technology will increase over this period

This has not taken place and the formal sector, consequently, has not generated the required growth. Thus, the urban informal sector, using adoptive and appropriate technologies, has been able to utilize its capital more efficiently than the formal sector.

4.  ... that there would be capital for investments into the formal sector

in fact, the capital scarce condition of most less developed countries has not increased investments, and the urban informal sector, as an alternative, has been able to function in such conditions by using low-cost labour intensive and appropriate technologies.

Lewis Model: The Lewis Model, or dual-sector model, explains development through the transfer of surplus labour from a low-productivity rural sector to a high-productivity urban industrial sector. It assumes unlimited labour in rural areas, gradual wage increases in urban areas, and capital accumulation driving industrial growth.

Todaro Model: The Todaro Model focuses on rural-urban migration based on expected income rather than actual job availability. It suggests that people migrate to cities not only for existing jobs but for the perceived probability of finding one, often leading to urban unemployment and expansion of the informal sector.

Implications

The comparison between the Lewis Model and the realities of the urban informal sector reveals critical mismatches in assumptions about migration rates, industrial growth, technological advancement, and capital availability. Contrary to Lewis's expectations, the informal sector has not only absorbed excess rural labour but has also emerged as a necessary and adaptive component of urban economies.

This sector provides employment through labour-intensive and low-capital strategies, filling the gaps left by underperforming formal sectors. Policymakers must therefore recognize the informal sector not as a temporary anomaly but as a permanent fixture of economic life in many developing countries, warranting supportive policies that enhance its productivity, resilience, and integration into broader development strategies.