Reforming the industrial dispute & trade union acts.

AuthorPoddar, Tushar
PositionBy Invitation - Abstract


India's employment growth in recent years has been anemic. The economy added only about 2 million jobs each year in FY05-FY12, compared to 12 million a year in the five years before that. Moreover, increasing numbers of workers are leaving the workforce--the labor force participation rate fell by 3 percentage points over the same period. As a labor-abundant country, India should be generating jobs in labor-intensive manufacturing. However, the manufacturing sector saw a net decline of 5 million jobs in FY05FY10 at a time when industrial growth was very strong at over 9% during this period. The industries that are losing jobs are in the most labor-intensive sectors textiles, electronics, and apparel. Firms are substituting capital for labor.

This paper begins by looking at structural problems in India's labor market, and how they have hindered employment. We estimate how much growth is being foregone due to the lack of movement of surplus labor from agriculture to industry. We then focus on labor laws--two in particular that we believe could reap large dividends if they are reformed. We look at labor laws in other countries in order to distill lessons from how those labor laws have been revised. We conclude by looking at employment growth examples from some of the more successful manufacturing countries in Asia, Korea in particular.

The Labor Problem

In theory, India can realize significant labor market gains from its favorable demographics due to: 1) increases in labor input from the young; 2) economies of scale in operation--as a firm grows, it can initially have increasing returns to scale--whereby adding more labor and other inputs leads to a more than proportional increase in output; and 3) urbanization--moving labor from low-productivity agriculture to high-productivity industry and services.

In practice, the gains have been much smaller than they could have been. Employment growth has been anemic, as discussed above, and this is reducing the gains from labor input from the young. India's employment profile is remarkable for its small scale and informality. To escape stringent laws, entrepreneurs keep the scale of their operations small. Most workers are in small enterprises, with their share in enterprises employing less than six people at 65.6%. Self-employed workers constitute half the workforce.

According to research by the World Bank, the value added per worker in the informal sector is less than half of the value added per worker in the formal sector. Further, employers have no incentive to invest in skills of contractual workers or in providing insurance.

Complex labor laws incentivize firms to remain small and stay in the informal sector. This allows them to remain under the radar of labor officials and escape stringent provisions. The large number of laws leads to inspection visits by different officials under different laws, which increases transaction costs and opens up opportunities for rent-seeking. There is also no standardization of documentation required or time periods for which records have to be kept. The inflexibility of labor laws has prevented large-scale employment growth in manufacturing. Moving workers from the informal to the formal sector can unleash productivity growth. In addition, formal workers in the formal sector pay taxes, so revenue collections can rise.

Labor mobility has also been hampered, as labor laws have reduced the demand for manufacturing labor. We use a simple framework to estimate the impact of labor mobility on growth rates. We broke down GDP growth into three components: 1) the contribution from sectoral increases in labor productivity, suitably weighted by the sector's share of GDP; 2) the contribution from growth in the labor force in the sector, in the absence of labor mobility, again weighted by the sector's share of GDP; and 3) the impact on GDP growth from intersectoral labor mobility, in the presence of differences in sectoral labor productivity levels.

These are summarized in the equation (1) below:



superscript A stands for agriculture, I stands for industry, S stands for services.

g: GDP growth

s: share of a sector in GDP

n: natural rate of growth of labor force in the sector

l: share of a sector in total employment

[PI]: level of labor productivity

[pi]: growth rate of labor productivity

m: the net movement of labor between sectors (e.g., [m.sup.AS] stands for labor movement from agricultural to industry).

The contribution of inter-sectoral labor mobility on overall GDP growth is represented by:


We find that labor is four times more productive in industry and six times more productive in services compared to agriculture (Exhibit 3). We measured the impact on GDP of urbanization by looking at productivity differences...

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