Time to gain from labour reforms

May 17 2014, 21:43 IST
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SummaryRecent Supreme Court action has reintroduced labour reform into Indias public debate. Even modest deregulation has improved total factor productivity substantially; this sets the scene for a deep liberalising reform

India has some of the more restrictive labour laws in the world, but a large informal sector to which these do not apply. Therefore, firms thinking of growing in size and becoming formal must trade off the advantages of size with the disadvantages of facing regulations. This dilemma keeps Indian firms small and informal unless they have a lot to gain by growing, i.e. when they are very good indeed. The result, it is argued, is a skewed firm size distribution with a very long tail of smaller, less productive firmsmany of which operate in the informal sectorwhich employ nearly 90% of the Indian workforce. Such a skewed outcome makes sense given the uneven protection of employment across the formal and informal sectors, with the latter being virtually unregulated. Strict labour laws may also result in market concentration, as these regulations act as a barrier to becoming large.

A number of studies have argued that strict (and obsolete) labour laws explain Indias manufacturing problem. Although the country has recorded impressive output growth rates since the 1970s, the share of manufactures in total output has remained stagnant at around 15%. Moreover, the top seven goods exported during 2012-13 represented over 50% of the country's total exports and these were all relatively capital-intensive goods: petroleum products, gems and jewellery, transport equipment, nuclear and mechanical machinery, electrical machinery, organic chemicals, and pharmaceutical products. In contrast, ready-made garments, traditionally an unskilled-labour-intensive export, saw its share in total Indian exports decline from 12.5% to less than 6% between 2000 and 2013.

There has been a recent renewal of interest in pursuing labour market reforms in India, and it has been an issue in the run-up to the current elections. Last year the ministry of finance argued in its Economic Survey that labour regulations appeared to be an impediment to the growth of jobs in manufacturing, a message emphasised in last months IMF Article IV review and earlier OECD Surveys (2007, 2011). Articles in the The Economist and the New York Times give colour to the scarcity of quality jobs in the country, and highlight how stringent labour laws appear to have played a key role. The latest in-depth official figures on employment from the 2011-12 Employment and Unemployment Survey (NSSO) suggest that only 20% of those employed in India are on a regular wage or salary with a contract. Clearly, such a system does not provide a

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