Inequality between Formal and Informal Sector: Factors and Solutions

Inequality was big issue in Indonesia, one of the most noticeable areas when formal and informal sector is in comparison, the gap between workers in this two sector reflect structural challenge in achieving welfare.

According to the ILO, the informal sector is the part of the economy that's not included in the scope of legal regulations or outside the supervision of the government. Jobs in the informal sector are not always protected by labor laws, do not have access to social security, and do not always follow safety standards or decent working conditions, like Teacher, Doctor, Civil servant, Banker, office worker, etc.

Also according to the ILO, formal sector is includes all economic activities regulated and protected by governments. This means workers in this sector get rights such as a minimum wage, clear working hours, and access to insurance or social security. The example are like Domestic Assistant, Street Vendor, casual labourers in construction, land lord, ministore owner, small agricultural workers, temporary helpers, Ojol and etc.

In Indonesia, a country with a population of over 270 million this could be interesting topic, According to the Badan Pusat Statistik (BPS) currently in February 2024 more than 142,18 million people or 59,17% are work in informal sector, or for instance we can see in this graph comparison between formal and informal sector based on Badan Pusat Statistik (BPS).

Data Source: Badan Pusat Statistik

From this data we can see that over years  informal sector always dominating the employed sector. Is that a good thing? Some may say yes but unfortunately if we see in the income factor or maybe other factor informal sector have a few minus point from the formal sector, Workers in the informal sector generally earn significantly less than those in the formal sector. some noticeable inequality between those factor are:

Wage Differences

According to the Badan Pusat Statistik  (BPS), the average monthly wage for workers in the formal sector is typically higher due to better regulatory protections, minimum wage laws, and the benefits that come with employment contracts. For example, the average monthly wage for formal sector workers in 2022 was around IDR 3.5 million (USD 220). 

Workers in the informal sector, by contrast, generally earn significantly less. Informal sector workers earn around 30-50% less than their formal sector. Based on data from the World Bank, the average monthly wage in the informal sector is IDR 1.7-2 million (USD 110-130).

Job Security and Social Protection

Workers in the formal sector enjoy greater job security, with formal employment contracts that provide stability and long term employment opportunities. They also have access to government mandatory social protections such as health insurance (BPJS Kesehatan), employment insurance (BPJS Ketenagakerjaan), paid leave, and pensions. 

In contrast, informal workers lack these benefits. Many rely on daily wages, have no employment contracts, and face job instability. They are also excluded from social protection program it will be complicated if they got into troubles, such as sudden illness, accidents, or unemployment.

Government Policies and Minimum Wage Regulations

The government sets minimum wage standards for formal sector workers in different regions, ensuring a baseline level of incsome. Minimum wage laws vary by province, with higher rates in urban areas. These policies help formal workers secure higher and more predictable incomes. 

Informal workers, on the other hand, are typically not covered by these minimum wage regulations, and their income often depends on market demand, negotiations with employers, or daily earnings. As a result, informal sector wages are usually lower, and the lack of regulation increases the contras with formal sector incomes.

Legal and Regulatory Barriers

Businesses and workers in the formal sector operate under a clear legal framework, which includes employment contracts, labor regulations, and business laws. This structure ensures that formal workers are protected by legal rights such as minimum wages, working hours, and benefits. 

The informal sector often exists outside the formal legal framework, which means workers and businesses lack legal recognition, making it difficult for informal workers to access government support, credit, and legal protections. 

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Inequality between those sector are driven by this factor

• Education and Skills, Formal sector workers generally have higher education and skills, allowing them access to better-paying jobs, while informal workers often have lower educational attainment and are confined to low paying jobs.

• Lack of Legal Protection and Social Security, Informal workers typically lack access to social protections like health insurance and pensions, leaving them vulnerable, unlike formal workers who enjoy these benefits.

• Job Stability, Formal sector jobs offer more stability, with contracts, regular wages, and career advancement opportunities, whereas informal workers face income instability and market fluctuations.

• Access to Technology and Capital, Formal workers have better access to technology and capital, boosting productivity and earnings, while informal workers rely on traditional tools and face challenges in accessing finance.

• Social Stigma, Informal work is often viewed as less prestigious, affecting societal perceptions and expectations of income, with formal jobs seen as more desirable.

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Some solution for the issue are

• Increase Access to Education and Skills Training, Expanding vocational training and certification programs can help informal workers improve their skills, leading to better job opportunities in the formal sector or enhanced earnings in the informal sector.

• Expand Social Security Coverage for Informal Workers, The government should enhance social protection for informal workers by increasing access to programs like BPJS Ketenagakerjaan, providing health insurance and pensions to improve their financial security.

• Strengthen Inclusive Policies for the Informal Sector, Implementing inclusive policies, such as simplifying the legalization process for small businesses and increasing access to microcredit, can empower informal workers to boost their productivity and income.

• Digitalization and Improved Access to Technology, Enhancing access to digital technology can open new markets for informal workers. Government initiatives should include digital training and improving internet infrastructure to help informal workers leverage technology for better earnings.

• Social Awareness Campaigns,  Promoting a positive perception of informal work through social awareness campaigns can help reduce stigma and enhance appreciation for informal workers, motivating them to improve their contributions to the economy.