The labour reform myth

No evidence to show labour laws are the only, or even main, constraint to growth.

Written by Pranab Bardhan | Updated: August 23, 2014 8:35 am
It is not clear that the rigid law on retrenchment is always the binding constraint on manufacturing expansion. It is not clear that the rigid law on retrenchment is always the binding constraint on manufacturing expansion.

By: Pranab Bardhan

Many economists and businessmen regard the reform of labour law as vital for the proposed revival of the manufacturing sector in India. In a widely noted move, the Rajasthan government has already taken a step towards amending Chapter VB of the Industrial Disputes Act (IDA), raising the exemption limit in the law that restricts laying off workers without government permission to firms with more than 300 workers. The Haryana government has also indicated similar intentions. Such experimentations at the state level, particularly when the implementation of labour laws is in the hands of state governments, is in principle a step in the right direction. But there are reasons to believe that if people expect big changes in output and employment simply as a result of such reforms, they may be in for a big disappointment.

First, it is not clear that the rigid law on retrenchment is always the binding constraint on manufacturing expansion. Take the highly labour-intensive garments industry, for example. A combined dataset (for formal-sector firms from the Annual Survey of Industries and informal-sector firms from the National Sample Survey) shows that about 92 per cent of garment firms in India have fewer than eight employees (the bunching of firms is around the eight-employee size, not the below-100-employee size, as one would have expected). Labour law cannot discourage an eight-employee firm from expanding to an 80-employee firm since Chapter VB of the IDA does not kick in until the firm reaches the size of 100 employees. So the binding constraints on the expansion of that eight-employee firm may have to do with inadequate credit and marketing opportunity, erratic power supply, wretched roads, bureaucratic regulations etc. There are good statistical studies by some economists which show that states with more rigid labour laws have had lower industrial growth and that labour laws can be a constraint. But these studies do not show that they are the only or even the main constraint. I do not know of a single statistical study or growth decomposition exercise in India that shows the relative dominance of the labour law constraint over other constraints. By constantly repeating the same objection about labour laws, some people may be barking up the wrong tree.

Second, Rajasthan is not the first state to relax Chapter VB. Gujarat relaxed it for special economic zones in 2004, Andhra Pradesh did so in 2006. Uttar Pradesh’s 1983 relaxation, which remained in force for 20 years, applied to the whole state — it raised the exemption limit to what Rajasthan is proposing now. I have not seen any serious study of the effects of these relaxations on job creation. Contrary to the recent election propaganda, the Gujarat model of development has not been particularly exemplary on job creation. A large part of its high manufacturing growth has been in petrochemicals and refineries, which are highly capital intensive. Does anyone believe that the UP relaxation for nearly 20 years led to a great many manufacturing jobs? If that did not happen, it may be largely due to the other constraints mentioned above. At an all-India level, why is it that the large and high-growth service sector has led to such little job growth (outside construction) over the last two decades? The IDA applies to industries, not to the service sector.

Third, over the decades, how many states have really strictly followed the labour laws? There are many cases of a state government looking the other way when they are violated. An important part of labour laws in India is the Contract Labour (Regulation and Abolition) Act, which restricts employment of short-term workers without benefits. Yet, it is well known that this act remains mostly on paper. According to an estimate based on Annual Survey of Industries data by A. Sood, P. Nath, and S. Ghosh in “Deregulating Capital, Regulating Labour” (Economic and Political Weekly, June 28), in 2009-10, about half of the workers in factories with more than 5,000 workers were employed through contractors. In factories employing between 100 and 5,000 workers, more than a quarter were contract workers. Similarly, an estimate from National Sample Survey data suggests that in 2011-12, about 80 per cent of workers in organised manufacturing either had no written job contracts or the contract was for less than one year. All this has clearly given employers a great deal of flexibility. If Indian labour laws were really that stringent in practice, how is it that during the downturn around 2008, nearly one million workers quickly lost their jobs in labour-intensive export sectors?

I am actually very much in favour of labour law reform. I’d even support abolishing the firm size limit on retrenchment altogether, provided there is a provision for adequate unemployment benefits. Allowing more flexibility in hiring and firing has to be combined with a reasonable scheme of unemployment compensation from an earmarked fund, to which employers as well employees should regularly contribute. No Indian politician has yet gathered the courage or imagination to come up with such a package deal.

More importantly, the whole gamut of Indian labour laws requires a major overhaul, not just Chapter VB of the IDA. The Trade Unions Act, 1926, allowing any seven workers to form a union, rampant union rivalry and lack of recognised trade unions as negotiating agents etc have led to a highly fragmented labour movement and a chaotic shop floor. More than 10 years back, the Second National Commission on Labour made some useful recommendations to change this state of affairs, but they remained mostly unimplemented. Meanwhile, there are some changes afoot in the grassroots Indian labour scene. While some businessmen continue to think in an adversarial way of “flexibility” as being “union-free”, there are new kinds of party-independent unions (for example, the New Trade Union Initiative), which are trying to mediate in the shaping and sustaining of labour-friendly practices that are compatible with global competitiveness and high productivity. Instead of constantly repeating the same mantra about Chapter VB, the Indian policy community should think of imaginative overall reforms that may help both labour and capital.
The writer is professor of graduate school at the department of economics, University of California, Berkeley

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First Published on: August 23, 2014 1:16 am
  1. S
    Feb 27, 2015 at 9:58 pm
    Increase in the speed of car depends directly on the good breaks. So also to increase employment, it is necessary for the employer be given to fire them. It is simply illogical and vote bank policies to restrict employers to fire an inefficient, trouble maker, and abusive work force. The Govt’s so far had harmed the labour tremendously be getting them alkl types of sauards and securities of service. These only gave rise to insolent, work shirkers, unionist minded persons to only har the management with imunity. This has only and simply restrained employers to get more people in their factories and industrial establishments, due to logical fear that if these insolent workers themselves create production problems, employer will not be able to throw them out, whatever their instigations and insolencies, All logics defy the law that an employer who invests 5, 10,20, 50 or more crores in Industries, but is unable to shunt them out if the market situation changes and there is a slump period ahead. Why must he have to depend on corrupt labour inspectors to even shunt out an excess labour. The only legitimate demand by the labour is the period between when he is dismissed and period when he is able to get a fresh employment. The solution is simple. A provision be made in any one fo the labour laws that an employee with service record of minimum 2 years, when dismissed or laid off suddenly, the law should provide sacked worker 180 % of last draw wages for 2 months, 60 % for next 2 months, and 40 % for next 2 months, and during this six months period, he must obtain a job to whatever maximum he is found worth in the open market. The moment he is emplo, his stipend will stop, and any illegal withdrawal be treated as criminal offence punishable with 200 ^ penalty, and fior extended period, a small jail terms provision will be called for. Another point of blackmail by labour force is their mischief to obtain advance or loan from the company, thereafter, starts shirking work, or refuses to get the loan adjusted on monthly times, in which case, all loans must be given only by the Government against proper securities and surities, so that they are not able to blackmail his employer. Govt can recover their dues, but an employer can give loans or advances only to straight inviting labour problems. Suraj Parkash Tuteja 9315879780
    1. B
      Aug 24, 2014 at 11:12 am
      Only policies of Govt. are responsible for poor growth of India. Politicians have kept firm grips on economy and economic activities. This gives them sense to be like God as nothing can happen without their pleasure. And from here starts all problems. Just loosen the grip and see results.
      1. G
        GIRI RAJ
        Aug 23, 2014 at 10:20 am
        Only motive of most of businessman is to earn profit . For them workers are like a mangoes so that they can be squeezed to draw everything out of them .Laws protecting the rights of workers can not be held to ransom in to hands of employers . There should be a right balance between the two . A good society is that which not only encourage the workers with incentives but also care and protect elderly ,child and weaker who are Integral part of the society . They can not be thrown in to Indian ocean . Welfare schemes for their benefit can not be discontinued .
        1. S
          Aug 23, 2014 at 7:11 pm
          I have worked in manufacturing industry at various levels and my essment is 1.Labour movement and trade unions have been high jacked by lumpen elements . They take a hefty amount from owners and just don't do any good to ordinary worker or company.This is same as Hafta wasul at markets .2. Labour Department and Govt. machinery is next link to this Hafta wasul Syndrome .3. Owners don't want to invest right money and follow all shortcuts believing they can manage through above agents on their payroll. Even if they invest the Hafta wasul won't go.4.Large corporations just look other way when they subcontract or outsource jobs to SMEs 5.The w setup is working on distrust ,thuggery and bribes . 6. Honest Trade Unions must get out of the clutches of the political parties and work together Industry ociations on mive education and training to all stake holders .Let every one understand that there is no prosperity without hard work and honest efforts .One simple example is implementation of Quality Awarness and Systems in engineering industry .This was spearheaded by CII and today the awareness and implementation is quite appreciable . We see a no .of companies achieve Zero or very low PPM levels of defected parts .S.DuttGurgaon
          1. S
            Aug 23, 2014 at 8:51 pm
            It is better to provide for compensation policies for lay-offs irrespective of the size of the company and covering all types and levels of employment. That way any manition based on size of the company can be avoided.
            1. T
              Thomas George
              Aug 23, 2014 at 3:52 am
              A business hires people to do some work for mutually-agreed upon payments. In my opinion, the terms of such a contract should be mutually agreed on. If labour unions and the government so wish, they may ist employees in modifying contracts to the extent acceptable to both parties. The government, aka labour department and the courts, have no right to rigidly define any terms beyond a bonafide mutual agreement; but, they have the obligation to ensure that working conditions are safe and healthy.
              1. T
                Thomas George
                Aug 23, 2014 at 4:37 am
                a. Maintain a stable currency with low interest rates by not increasing money supply for government spending. Any increase in money supply should be justified by an ociated increase in output to prevent inflation.b. Selling products at lower prices to targeted groups cause corruption; s that policy. Those who can afford petroleum and electricity must pay for it in full -- all cross-subsidies must end.c. Farming must be protected with universal mandatory insurance coverage.d. Farm departments and agricultural universities have failed in providing any meaningful istance to farmers. Experts must travel around the country isting farmers in producing safe food at high efficiency. The availability of insurance allows farmers to experiment new methods suggested by experts.e. Employment must be at-will of both the employer and employee. All provisions should be governed by mutual agreement, rather than rigid laws.f. Maintain a stable legal framework. Settle legal disputes in a maximum of a week. Settle civil disputes in a maximum of six months other than in cases where the parties agree to a longer term discovery process because all facts have not been ascertained.g. Combine welfare with skills upgrade programs to create a modern work force.h. Encourage entrepreneurship. Small businesses, even sole businesses, increase economic output. Entrepreneurship is a mindset that must be developed right from school.i. Education must focus more on individual responsibilities than rights. We have no intrinsic right to anything that others had to work for. Therefore, right to food is moot. You either grow yours, buy from those who grow, or hopefully find someone who is willing to give you free food.Therefore: A good society focuses on responsibilities and hold individuals responsible for their future. A good society provides a safety net (insurance) to those who takes those responsibilities. A good society does not mandate income redistribution, but encourages voluntary contributions to welfare.
                1. A
                  Ashok Vaishnav
                  Aug 23, 2014 at 4:16 am
                  It would be axiomatic to state that labour laws cannot be the onlyconstraints that impeded the robust growth of manufacturing sector. In fact as the Theory of Constraints wouldgo, the defining constraint(s) wouldnecessarily keep shifting as well.It can also be safely umed that larger, hard, constraints – infrastructure,power, marketing, and technology – would easily find attention and may even betaken for remedial actions.However, the softer constraints like legislative and regulatoryenvironment, real delivery of the financial credit policy initiatives and rightmix of skills do require a closer look, at the local level.At the present juncture, one does feel happy that these issues have beentaken up for active and intense discussions at respective forums. Let us hopethat these discussions will translate into meaningful actions, and that thediscussions will be sustained on the basis of feedback as we go along.
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