A toxic employment benefits regime

India’s most important labour reform has nothing to do with the ability to fire employees.

Updated: February 10, 2014 9:24:58 am
India’s most important labour reform has nothing to do with the ability to fire employees. PTI India’s most important labour reform has nothing to do with the ability to fire employees. PTI

India’s economically questionable employee benefits regime means that the take-home salary of someone earning Rs 55,000 per month is only 9 per cent less than their gross salary, while the take-home salary of a person who earns Rs 5,500 a month is 49 per cent less than their gross salary.

While labour law reform is often equated with the ability of employers to freely hire and fire their employees, India will benefit more from fixing the current regressive benefits regime, which requires six-times greater deductions for a person earning a 10-times lower salary, is not competitive, and has ensured that 100 per cent of net job creation since 1991 has taken place in the informal sector. This war on formal employment has poisonous consequences — lower tax collection, uneven productivity, poor working conditions, lack of minimum wage enforcement and small firm size (80 per cent of India’s garment production takes place in units employing less than 15 people while 80 per cent of China’s takes place in units with more than 200 employees). Formal employment growth will be explosive if only five changes are made.

One, the mandatory 12 per cent employee provident fund contribution must be abolished. That provident funds are a means of providing social security is a myth. The median retirement amount in India is Rs 25,000. Poor management and harassment by the Employees Provident Fund Organisation (EPFO) has created 50 million orphan accounts and unclaimed balances that are no longer being credited with interest. The “myopia argument” — that low wage workers need to be protected from themselves — is superfluous because payroll deduction rates can’t be higher than the savings rate. Instead of raising the salary cap, abolishing this 12 per cent will raise take-home incomes and eliminate employees’ reluctance for formal employment.

Two, the employee pension scheme must be scrapped and we must move back to the pre-1995 status. In 1995, the EPFO diverted 80 per cent of employer contributions towards the poorly designed employee pension scheme (EPS). EPS’s liabilities were, at last count, officially estimated at Rs 50,000 crore more than its assets. The EPFO’s attempts to fill this hole by reducing benefits are a default, and employees should be allowed to opt out of EPS and revert back to pre-1995 defined contribution accounts. EPS not only has the birth defect of benefits and contributions being defined but it also provides a lower monthly pension relative to a deferred annuity from LIC or bank interest on the retirement lump sum. Making the minimum pension Rs 1,000 — as was done last week — is election politics. It will only make things much worse.

Three, employees must be allowed to choose between the EPFO and the national pension scheme. The EPFO is the most expensive government securities mutual fund in the world with costs equivalent to 4.4 per cent of contributions. Most gilt funds — even public sector ones — charge 0.25 per cent of contributions. Giving employees an option to pay their monthly provident fund dues to either the EPFO or the national pension scheme will create a portable back-pack pension with higher competition and lower costs.

Four, employees must be allowed to choose between the Employees State Insurance Corporation (ESIC) and health insurance. The health insurance programme run by the ESIC provides poor value for money, with only 48 per cent of contributions being paid out as benefits. Most private and public health insurance plans have a 100 per cent-plus claims ratio. The unfair payout ratio has allowed ESIC to unfairly accumulate Rs 28,000 crore in reserves, which are currently invested in government securities and bank deposits. Employees must be given an option to opt out of the ESIC programme and pay their monthly contributions to any IRDA-regulated health insurance plan.

Five, the five-year limit must be abolished or gratuity must be removed. Gratuity is a defined benefit lump sum payable at the time of retirement to the employee. It gives the employee 15-days of salary for every year of service. But this benefit is only applicable after five years of service, and as the employment contract has morphed from a lifetime contract to a taxicab relationship, most employees with short tenures do not get gratuity benefits. The political optics of abolishing gratuity make that infeasible. It is better to remove the five-year limit and create a monthly or annual payment option to create transparency and fairness since gratuity is built into most cost-to-company calculations.

Benefits regimes are innovating globally because of demographic challenges and a realisation that employee benefits are not “over and above” gross salary but come out of it. Chrysler is owned by retirees who got their stake in lieu of unfunded pensions. Britain recently introduced a new employment contract for “employee owners” who surrender the right to redundancy payments in exchange for capital gains-exempt equity. This scheme will probably fail for reasons similar to why “equity for land” failed in India — what the price should be, who bears project-failure risk, who gives liquidity, etc. But policymakers trying to catalyse job creation in France, Spain, USA, Japan, Brazil and China agree that one size does not fit all and are experimenting with giving employees more control over how they are paid.

Informal employment is the slavery of the 21st Century. Only 8 per cent of India’s labour force gets minimum wages, employment benefits, safe working conditions and leave benefits. Increasing formal job creation is India’s biggest challenge and the right place to start that tricky journey is fixing our toxic employment benefits regime.

The writer is chairman, Teamlease Services

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