Column: Reforming factor markets

Jun 20 2014, 00:02 IST
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SummaryThe first generation of reforms focused on product markets; the next round should target factor markets

In many ways the recent election was historic, with record turnout and the first single-party government in a generation, defying what political and social scientists have been saying for years: that India’s pluralism would translate into coalition governments till the eye can see. But despite that, political capital is not infinite, given that the government needs to work closely with the states and build alliances in the Upper House. Therefore, the government will have to carefully pick its hits in the first year.

Yesterday we focused on the need to tackle food inflation and the importance of jumpstarting coal production and debottlenecking land constrains to drive the capex cycle. Today we focus on something even more fundamental—labour reforms—and conclude with the opportunities and risks posed by the upcoming budget and monsoon.

The motivation for revisiting labour laws is obvious. There are concerns that India has recently experienced jobless growth. One explanation for this is that despite having an abundance of unskilled labour—India’s comparative advantage—Indian firms have expanded largely in capital-intensive sectors (engineering goods, pharmaceuticals) or used excessively capital-intensive technologies in other sectors, resulting in a sub-optimally low utilisation of labour. Labour laws are deemed a key culprit. By making firing, and therefore hiring, difficult and introducing other rigidities they have essentially bid-up the relative cost of labour, and induced firms into operating at sub-optimally high (from a societal perspective) capital-intensive technologies.

Professors Jagdish Bhagwati and Arvind Panagariya effectively demonstrate how the textile industry, for example, is littered with small firms in India because labour laws have constricted expansion, and therefore from realising economies of scale, increasing productivity and competing on the world stage. Almost 93% of workers in the labour-intensive textile industry are employed in firms employing 49 workers or less—in large part due to labour laws. In contrast, more than half of China’s textile workers work in firms with over 200 employees!—a far cry from China’s size distribution (Page 134, “India’s Tryst With Destiny,” by Jagdish Bhagwati and Arvind Panagariya).

But a glimmer of hope is finally emerging. Recently, the Rajasthan government amended three important laws—Industrial Disputes Act, Factories Act and Contract Labour Act—to make hiring and firing of employees more flexible. However, the laws fall on the concurrent list and need Presidential (not legislative) approval. If they do secure it, this could serve as a powerful demonstration effect to other states, who may also be induced into liberalising laws for fear of

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