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Rural Infrastructure: The Role of Informal Construction Economies in Development

February 10, 2017
This piece explores how construction companies which aren’t formally organized, often built entirely on relationships and informal agreements, can be a perfect remedy for infrastructural deficits in rural areas of India. We explore how informal economies encourage economic growth. Critically, we reach the conclusion that developing economies must tailor policy to allow for informal economies to grow while simultaneously ensuring they do not become exploitative. The piece develops a comprehensive behavioral economic framework for understanding informal construction economies as a commitment device and uses a series of interviews with the author’s own family to illustrate these powerhouse industries.

Meghalaya

In the state of Meghalaya, India, there is a small town nestled into the hillside of the foothills of the Himalayas. Called Tura, the town has a population of barely over 10,000. Nestled therein is one central stairway which leads from a dirt-paved highway with step gradations of varying steepness, each a step closer to the bottom of the town (called Fancy Valley) and a small water formation. As one walks through this town, one house stands out more than all of those around it. The house is a mansion even by American, non-rural standards, with a large sunny verandah and three floors. Contrasted with the thatched roof across the steps from it, this house defies all tropes in the town and stands alone.

This house belongs to a mogul and philanthropist known throughout the village. To the author, he is known simply through his respectful moniker as “Bade Papa” (pronounced Buh-ray Papa, intimating seniority to one’s father). Bade Papa is the construction don of this town. He employs a significant number of workers in the town in the course of his infrastructure projects. He re-paved the main town stair, built much of the downtown, contributed to one of the first hotels in the area, developed the border fence with Bangladesh several miles away through negotiation with the India Border Security Force, and essentially singlehandedly built the economy of the town through extensive public works contracts and private investments. His work is essential to the creation of critical infrastructure which allows children to avoid the denser parts of the surrounding jungle or the unforgiving undulation of the surrounding hills when going to school, elderly women to make their way to the water at the bottom of the hill to get fresh water for the day’s work without slipping and breaking a hip, and men to develop skills which they use to get jobs in cities more populous and filled with opportunity like Patna in Bihar.

Don’t let this picture fool you; Bade Papa is a boss of a construction company which by most Western measures would be considered nepotistic and exploitative. His workers all obtained jobs by leveraging relationships with him, his family, or other workers in the company (called a “relational network”), and few are given formal contracts. Most of them function without a formal pension or set of benefits, instead biding their time until another job comes by. Were one of them to be injured on the job, there is not an extant worker’s compensation system to guarantee some form of consumption smoothing. Rather, they must rely on trust and the relational networks in the company. Angering Bade Papa is a road to ruin.

This is the classic story of an informal economy. While this term tends to be vague in the literature, it generally follows a set of general guidelines between parties. Jobs are determined by informal bargaining, or relational networks. This allows contractors greater control over their labor costs, a stable workforce, and more flexibility in scheduling work hours. Workers are in turn willing to sacrifice such monetary benefits as a guaranteed hourly wage, preliminary pay for overtime hours, and compensation for all hours worked; such is the nature of imperfect markets. Using the framework described by Nobel Prize winners Hart and Holstrom in describing contracts, it becomes clear that the rewards to workers are non-pecuniary, autonomy, job security, and a wage of some form. It also makes sense that such workers are rarely better off outside the bounds of the contract game, but rather rely on the informal construction economy to earn a living wage. The question becomes whether or not this is a good thing, and how to address it with policy. This long-form piece will look at when these economies are justified and how to ensure they do not spiral out of control.

Economic Rationale

There is a body of behavioral finance which makes the argument that commitment devices seem to generate in and of themselves a sense of positive utility even if they enforce a disutility. The most famous example is the Israeli preschool experiment , in which a daycare decided to fine parents who consistently were late to pick up their children. Rather than fixing the problem, the preschool found that more parents would come late as now any inherent disutility from their guilt was balanced out by a utility from being late and the mental behavioral ability to “license” that guilt by paying it away. In the same way, informal economies pay away the informality.

Informal economies use trust networks and the promise of quick development and relational strength to develop the same level of utility as the fines do in the daycare setting, in that both crowd out what are otherwise disutilities on the community. Often built on the back of traditional values, they can be extremely powerful and contingent on principles like honor or respect. It is no wonder that above Bade Papa is deemed a savior and has been singlehandedly praised for work in charitable spheres; they reinforce these networks. This has a double-edged effect. By cancelling out the disutility of working in informal setting, it allows workers to work more flexibly and often faster. It also means workers, when betrayed by some market failure or deliberate action by a supervisor, often have no method of recourse.

This analysis confirms a simple intuition: the main areas where such informal economies develop and are successful in the sense that they contribute positively in the short- and, to some extent, in the long-run, tend to be rural or agrarian economies. The relational networks and the cultural underpinnings have been repeatedly associated in a sociologically rigorous manner to the developing economy. Portes and Haller describe an “enclave” state which “naturally leads to an enclave of formal capitalism and legal enforcement of contracts and a largely self-regulated economy on the outside.” Such states are typical of developing countries. In many such cases, heterogeneous populations give rise to networked societies “accustomed to relying on their own devices for survival … and view informal enterprise as a normal and justified part of life.” Such arguments stand in stark contrast to frameworks like the Kuznets literature, wherein modern economic growth was supposed to encompass an increase in the scale of non-agrarian sectors, allowing for a growing role for business entities which limit individual liability and disaggregate from the individual level.

<p><em><span style="font-weight: 400;">(</span></em><strong><em>Image:</em></strong> <em><span style="font-weight: 400;">Largest informal economies by the percent of national GDP. We can immediately see that they are populated by heterogeneous and developing nations as predicted by our analysis and that of Portes and Haller.</span></em> <strong><em>Source:</em></strong> <em><span style="font-weight: 400;"><a href="http://www.resultsfordevelopment.org/sites/resultsfordevelopment.org/files/resources/Skills%20for%20Employability%20in%20the%20Informal%20Economy.pdf" target="_blank">Results for Development Institute</a></span></em><em><span style="font-weight: 400;">)</span></em></p>

(Image: Largest informal economies by the percent of national GDP. We can immediately see that they are populated by heterogeneous and developing nations as predicted by our analysis and that of Portes and Haller. Source: Results for Development Institute)

The analysis here thus investigates when the efficiency gains of the informal economy are outweighed by the negative externalities imposed on laborers through exploitative labor practices. The essential tradeoff is an increase in factor productivity in the microeconomic production function associated with the single firm, allowing infrastructural development and a positive effect on the Phillips Curve. In exchange, the long-run Phillips Curve is eventually lower than it may have been in the geographic area where the economy functions. This occurs due to lower injury compensation, lower tax payments allowing allocative redistribution, and due to loss of efficiency from a lack of formal coordination above some threshold. This brief rationale justifies the role of policy in mediating these informal economies on the dimension of time. If they run for too long, these inefficiencies “catch up” with the productivity gain. How can policy intervene on the part of the long-run stability of areas where this works? 

Informal Construction at Risk: The Status Quo

Since India’s 1991 liberalization policies, the informal economy and its proletariat of workers has grown considerably in a manner which has actually drawn upon the gradual divesting from public sector enterprises. As workers whose salaries were contingent on these sectors left their posts, they were quickly sucked into the informal sectors. As one may expect, the fraction of informal employees covered by critical government programs is one-fifteenth that of formal employees. Manufacturing construction  accounted for 76 per cent of all workers in the non-agriculture informal sector. These sectors accounted for 17% of the rural economy.

The sustained success and large scale of the informal economy indicate that it does more than compete with the formal sector. They suggest rather that the formal economy has a complementary labor market good in the informal sector. Low informal wages and high informal flexibility can allow formal economies to become scalable and grow throughout the nation. 

However, recent events have put this relationship in jeopardy. Modi’s demonetisation has strongly affected the informal financial sector, which in turn is the reason many informal construction and infrastructural development projects are funded. These effects will be felt in the future by the formal sector as well, labor demand will fall in the informal sector and close off certain rural markets from adequate infrastructural development in as speedy a fashion.

Success stories of informal construction industries abound. The New York Times conducted an in-depth analysis on the slum Dharavi, where workshops with an annual economic output estimated to be between $600 million and over $1 billion form a core informal economy. Such economies are largely self-sufficient, but also can become traps if one is not careful. In a classic Indian tale, Rajiv Gandhi’s $20 million housing program was overtaken by “local officials,” largely those at the center of informal economies like Bade Papa whose position in relational networks allowed them this leisure. The shantytown continues to be a shantytown today. The problem with informal economies is that they can’t break the cycle of informality and scale into formal businesses, allowing to break this cycle.

The policy context in India is extremely ignorant of these self-perpetuating realities, further so of how policies like demonetisation further mire this communities in such difficulties. In the words of Ruchi Hajela of Oxford University, “Rigid entry requirements that mandate secondary education as a prerequisite, and long course durations, are mismatched with the profile of casual workers.” By attaching skill premiums to educational attainment, the Indian government has shut off the pipeline from informal work to formal economies. Rather than re-emphasizing the IT sector, the government bears the onus of ensuring informal economies are not a lifelong sentence. Dhall’s research confirms that if anything, the Indian economy in the formal sector pushes Indian locals further into the informal sector away from being on any government programs or attaining any form of government aid. Only about one tenth of government rural investment actually directly goes to programs which increase productive capacities in these communities.

<em><strong>(Image:</strong> <span style="font-weight: 400;">The percentage of people with formal vocational education in India by industry. Notice the bolded juxtaposition. Computer trades are extremely high thanks to a government focus, leaving the civil engineering and construction industries in the informal sector.</span> <strong>Source:</strong> <span style="font-weight: 400;"><a href="http://www.teamlease.com/media/1149/teamlease_labourreport2009.pdf" target="_blank">India Labour Report</a>.</span><span style="font-weight: 400;">)</span></em>(Image: The percentage of people with formal vocational education in India by industry. Notice the bolded juxtaposition. Computer trades are extremely high thanks to a government focus, leaving the civil engineering and construction industries in the informal sector. Source: India Labour Report.)

Recommendations

Having developed this empirical outlook on the Indian informal construction economy, we now substantiate the recommendations to be made. As has been emphasized since the introduction of the axiomatic economic reasoning, the government’s goal should be to encourage relational informal economies in rural areas, while protecting them from becoming exploitative. This is especially important for developing areas which are not yet integrated into the economy.

Segmentation

An interesting note is that informal economies have “pre-segmented” the market for the most consequential government programs. They in many ways serve as enclaves of the disaffected, and can be used to isolate those who are in most need of government aid. If government were to offer low-cost (or free) welfare such as workers’ compensation, wage insurance, and Social Security to workers and their communities while they were involved in an informal economy, government can prevent a number of externalities associated with informality. To do this without eroding the efficiency gains, the microfinance industry’s practice of having agrarian women as stewards of men’s work may help. Having household members who are not in the industry bring proof of work, be it a signed document or a piece of equipment, to a disbursement office, can provide critical infrastructure without forcing a formal institution on the leader of these institutions and without forcing disbursement through the informal network’s ringleader themselves.

Education

The most important forms of welfare are of course financial literacy courses, wage theft education, and targeted programs for increasing involvement in formal economy in time. Here one can leverage relational networks to encourage vocational and literacy training. Men like Bade Papa would be incentivized to take up this cause, as it provides free human capital improvement. While it may seem difficult to bring this into informal systems, it is rather simpler to do so because the relational networks can expedite a process otherwise contingent on systems involving several levels of registration.

Contracting

Next, the government ought to capitalize on the progress made by informal economies. When an informal economy conducts infrastructure projects correctly, the government should have reward systems in place to incentivize further construction. Bade Papa’s contract for the border fence with Bangladesh is a great example of a government imbuing values like national pride into relational networks, simultaneously reinforcing them and leveraging them to build otherwise unreachable infrastructure projects.

Transitioning

Finally, the creation of “informal shelters” which can serve as halfway houses and help informal workers develop formal resumes and recognize the skills which they have accrued in their informal economies can improve their reintegration into formal economies. By creating an institution like this, and by encouraging on a community basis with tactics not unlike new community policing programs in developing countries, exploitation can be mitigated in the long run.

These four recommendations can collectively make the Indian government recognize, encourage, and leverage the strengths of these informal enclaves. Perhaps in the process they can develop Dharavis into Turas, slums into towns, and towns into economies.

 

Works Cited

[1] http://onlinelibrary.wiley.com/doi/10.1525/aa.1988.90.1.02a00030/full 

[2] https://www.cesifo-group.de/dms/…der…/pse13_Simon__19078548_en.pdf 

[3] http://onlinelibrary.wiley.com/doi/10.1111/j.1468-232X.1971.tb00007.x/full 

[4] http://freakonomics.com/2013/10/23/what-makes-people-do-what-they-do/

[5] http://www.econ.yale.edu/~gtb3/Gharad_Bryan/Research_files/AnnualReviewFinal.pdf 

[6] http://www.academia.edu/29781396/The_Informal_Economy 

[7] http://www.thehindu.com/opinion/columns/Chandrasekhar/indias-informal-economy/article6375902.ece 

[8] http://www.resultsfordevelopment.org/sites/resultsfordevelopment.org/files/resources/Skills%20for%20Employability%20in%20the%20Informal%20Economy.pdf 

[9] http://krieger.jhu.edu/sociology/wp-content/uploads/sites/28/2012/02/An-Economic-Sociology-of-Informal-Work-The-Case-of-India.pdf 

[10] www.ilo.org/surveydata/index.php/catalog/177/download/1781

[11] www.ilo.org/wcmsp5/groups/public/—asia/—ro…/wcms_342333.pdf 

[12] http://natlex.ilo.ch/public/english/bureau/stat/download/papers/wp53.pdf 

[13] http://www.firstpost.com/india/demonetisation-will-hit-agriculture-informal-sector-workers-the-most-study-3106004.html 

[14] http://www.nytimes.com/2011/12/29/world/asia/in-indian-slum-misery-work-politics-and-hope.html 

[15] http://www.economist.com/news/asia/21586891-activities-out-sticks-may-add-more-gdp-was-thought-hidden-value 

[16] http://www.skope.ox.ac.uk/wp-content/uploads/2013/11/WP111.pdf 

[17] http://www.tribuneindia.com/2008/20080105/real1.htm 

[18] http://www.economist.com/news/finance-and-economics/21697870-meagre-rainfall-only-part-problem-indias-farmers-dry-times 

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