Friday, Oct 31, 2014

The labour reform myth

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.
Written by Pranab Bardhan | Posted: August 23, 2014 1:16 am | Updated: August 23, 2014 8:35 am

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 continued…

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