Will Fixing Labor Regulations Help Solve India’s Employment Woes?

8 May 2017
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The renewed economic debate that loosening and simplifying India's labor laws will address its employment problems seems to overlook the quality dimension of jobs.

The notion that loosening, simplifying and updating India’s old and intricate web of labor regulations will address its employment problems has taken center stage in economic debates once again. The central government’s proposal to collapse the existing 44 central labor laws into four codes is on the table. The main motive behind the proposed reforms is to provide more flexibility for companies to adjust their workforce in response to shifts in demand.  This flexibility, many believe, will enable companies to operate more efficiently, fuelling growth of the manufacturing sector.

But the exclusive focus on an expansion of the quantity of employment overlooks the quality dimension. What will the effect of the proposed reforms be on the employment and welfare of workers?

With an average annual Gross Domestic Product (GDP) growth rate of 6.5 percent between 1990 to 2015, India has emerged as one of the fastest-growing economies in the world. But the impressive growth in GDP has failed to create enough good jobs in the economy, particularly in the manufacturing sector. The employment elasticity of economic growth – a measure of how much employment is generated relative to growth in GDP – in the manufacturing sector has declined from 0.59 for the period 1972-73 to 1993-94 to 0.18 for the period 1993-94 to 2009-10.

Economists often point to the current labor regulation regime as an obstacle to job growth in the country. Besides the 44 central labor laws, there are around 200 state labor legislations in place. A World Bank report in 2008 describes Indian labor law regime as among the most restrictive and complex in the world, even though implementation is poor.

The debate on labor laws in India has mainly revolved around the Industrial Disputes Act (IDA), 1947, and the Contract Labor Act (CLA), 1970. The IDA provides for employment protection to regular workers by making it mandatory for employers to obtain prior permission from the central government for retrenchment, lay-off, and closure of the enterprise. It also spells out the compensation owed to workers upon dismissal. The CLA regulates contractual employment in establishments employing at least 20 workers. The Act calls for wage parity between contract workers and regular workers for performing the same work.

Much of the discourse on the Indian labor law regime revolves around the idea that strict rules restrict the ability of employers to effectively navigate demand shocks. If employers are unable to react to changes in the economy by retrenching workers when necessary, the idea goes, they will be reluctant to expand their workforces in the first place. These restrictions on hiring and firing are seen as generating inefficiencies in business, thereby discouraging job creation.

This line of thought may seem plausible, but it focuses only on the number of jobs created, brushing the qualitative aspect of job creation aside. Today, a major concern plaguing the Indian labor market is that of the contractualisation of employment. Such contractualisation is spiralling out of control even in the formal sectors of the economy. As per the Annual Survey of Industries, the share of temporary contract workers in formal manufacturing workforce has gone up from 13 percent in 1993-94 to 35 percent in 2011-12.

Temporary contract workers are informal workers who do not come under the purview of employment protection legislation, and can be fired at any time without prior notice or severance compensation. Their basic wages are about 30 percent lower than that of their regular counterparts, and they are not generally entitled to additional benefits and amenities such as provident fund, gratuity, bonus, medical facilities, and housing.

This trend toward informalization does not bode well for job quality and the welfare of workers. Besides, the overuse of temporary contractual workers induces high labor turnover and instability in the workforce, which creates a disincentive for employers to invest in training and skill development of their workers. Thus, informalization not only affects job quality, but also the productive capacity of a firm.

The proposed regulatory reform may indeed stimulate job creation. But its effect on job quality depends on whether it increases contractualization or reduces it. The dangerous growth of precarious or contract work calls for a broader focus than just on flexibility that may or may not improve employment.  There is a need to expand the frame of this debate to include the larger question of how to rein in the growth of temporary contract labor. The debate on labor regulations must center on how to ensure that workers get a fair share of economic growth, and how to ensure that a flexible labor law regime also improves the quality of employment, not just the quantity.