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Why it’s hard to reduce informality in the labour market Informal workers get a bad deal. They earn no pensions and get paid half as much as public sector employees do in Sri Lanka. As we discuss in our cover story, wages are low because informal sector firms are less productive than formal ones. They are also smaller, don’t have access to capital as easily, and stay on the sidelines to avoid catching the eye of officialdom. Simplifying taxes itself is not known to attract informal firms out of the shadows. If regulations are burdensome, particularly if a small company must pay high pension contributions and severance costs should it run into financial trouble in the future, a small business owner may decide to employ fewer people. In Sri Lanka, 70% of jobs are in the informal sector. Besides employment, this has wide implications for the economy too. A large informal sector is associated with low growth, low pay and poor-quality jobs. Informal firms pay measly wages and the jobs are tenuous. They also dodge both income and sales taxes. What has been missing is political ambition. To reduce informality and allow small businesses to flourish requires a more equal deployment of public resources (including for social protection when people lose their job), flexible labour laws, and simpler tax and business regulations.

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