Coagglomeration of Formal and Informal Manufacturing in India

Abstract

Most developing countries have large and persistent informal sector. Historically, the literature was dominated by strict duality viewpoint, where the formal and informal sectors are treated as two separate entities. However, in recent times, a new approach has developed where the formal and informal sectors are not binary but they often co-exist and feed into each other. Most academic work on agglomeration economies is based on developed countries where almost all production takes place in the formal sector. Apriori, there is no reason to believe that agglomeration economies do not extend to the informal sector. Hence, in this paper, we hypothesize that agglomeration economies can arise from the interaction between formal and informal firms as well. To check the validity of the hypothesis, we study the geographic distribution and Coagglomeration pattern between formal and informal manufacturing firms in India. Using the firm level National Sample Survey for unincorporated enterprises and Annual Survey of Industries data, we calculate the Ellison and Glaeser Coagglomeration index at 2-digit NIC level. Further, using the Marshall's theory of agglomeration, we create four kinds of linkages to capture the nature of interdependence between formal and informal firms, i.e. Buyer, Supplier, Labor and Technology. We find that there is heavy clustering of both formal and informal manufacturing firms in India, however, mostly in different areas, with few exceptions like Western Uttar Pradesh and Southern Tamil Nadu. Out of 22 major industries, we find high coagglomeration only in 7. The average value of coagglomeration index at aggregate level decreases from 0.00536 in 2000-01 to -0.0027 in 2015-16. This indicate towards reduced interdependence over time, however in few industries it remains high. The average value of labor linkage increased from 0.1889 in 2000-01 to 0.3651 in 2015-16, during the same period buyer linkage remained constant around 0.2481 and supplier linkage fell from 0.5755 to 0.2749. The technology linkage remained low throughout in the range of 0.02-0.03. Strong buyer and labor linkage mean subcontracting of inputs is the main motive driving the interaction between formal and informal firms.