Transition to labor law reform: state-level initiatives & informal sector labor relations.

AuthorShah, Hemal
PositionBy Invitation - Abstract

Restrictive, Archaic, Convoluted Labor Laws

For India to transition to a modern economy--from agriculture to industry, informal to formal sector, and shift to urbanization--she must realize her true growth potential by focusing on the creation of good quality jobs and infrastructure. One of the key enablers is the modernization of the labor market, which is regulated by extremely restrictive laws. This forces businesses to remain small, and in turn operate in the informal sector. About 450 million informal employees who make up 93 percent of the total workforce stand to benefit from reforms to labor laws and improve business productivity.

Informal or unorganized sector workers, by definition, are those employed in enterprises that use power and employ fewer than 10 people or do not use power and employ fewer than 20 people (Debroy & Bhandari, 2008). Common occupations include small farmers, fishermen, beedi packers/bonded laborers, migrant workers, contract and casual laborers (Planning Commission, 2001). Informal workers are often characterized as low-skilled, poorly paid and seldom covered by social security provisions. This paper uses the terms 'informal' and 'unorganized' interchangeably.

Indian labor legislation is convoluted, archaic, and restrictive in nature. About 50 Central laws overlap with 150 State regulations. The clauses of the Industrial Disputes Act (IDA) of 1947, one of the major regulations, were conceived under the British Raj. In 1976, the introduction of Chapter V-B to IDA decreed that firms employing 300+ people should seek government permission to effect lay-offs, retrenchments and closures. This was further restricted to firms with 100+ workers in 1982, making hiring or firing new workers extremely difficult even if they are inefficient (Sharma, 2006). The Trade Unions Act is as old as 1926 and Workmen's Compensation Act from 1923.

The 1970 Contract Labor Act allows firms to employ contract workers for tasks of permanent nature but the arbitrariness of the law allows the government to ban contract use if similar establishments use regular workers for that same task (Bhagwati & Panagariya, 2013). The 1948 Factories Act limits the maximum hours of work per week to 48, requires paid holiday for each 20 days of work, bans the employment of women for more than nine hours a day, among other things (Bhagwati & Panagariya, 2013).

Adverse Effects

Stringent labor regulations affect industrial development, thereby economic growth and jobs. Firms are disincentivized from expanding and harnessing the economies of scale and forced to remain informal. The World Bank's (2013a) World Development Report focusing on labor issues directly links larger, formal sector firms to a range of positive factors. Surveying businesses in 102 countries, the report found that larger firms (with more than 100 workers) are likely to be more productive.

For instance, value added per worker in India's informal manufacturing sector is on average about one-tenth that in the formal manufacturing sector (Sharma, 2009). The World Bank report also found that larger, formal sector firms innovate more, and compete in export markets, especially in the presence of foreign competitors. They are also likely to pay higher wages and control for worker characteristics like age or education through a wage premium. However, India misses out on capitalizing on such economies of scale. For example, about 84 percent of manufacturing firms in India are micro and small firms, employing less than 49 people. A miniscule 6 percent of ("medium size") firms employ between 50 and 199 people. Only 11 percent employ over 200 people ("large size"); in China large sized firms account for 52 percent (Hasan & Jandoc, 2012).

On the other hand, economic growth in India has not brought about sufficient jobs. For instance, overall employment, which experienced a steady annual growth of around 2 percent from 196190 (when average growth was about 3.5 percent) declined sharply to 1.5 percent during 1990-91. Employment further declined to around 1 percent during 199300, when growth rose to an average of 6 percent (World Bank, 2013b). This situation improved in 2000-2005 when India's GDP growth rate averaged at 7 percent, and employment went up by 1.6 percent (World Bank, 2013b). But as a u-turn, in 2005-2010 when growth averaged higher at 8 percentand employment dropped by 5.4 percent (World Bank, 2013b).

Even if employment increased slowly over the years, the rate of good jobs creation was going the opposite direction. While the formal sector grew slowly at 1.2 percent annually in 1983-94, this rate fell to 0.53 percent in 1994-2000 (Sharma, 2006). Overall, employment in India increased by 92.7 million during 2000-2005 but a mere 2.2 million during 2005-2010 (Mahambare & Nadkarni, 2011).Even then, the quality of jobs added to the economy was dismal. The small increase in aggregate employment of 2.2 million during the high economic growth, but low job growth period of 2005-2010 was due to a massive increase in informal or casual jobs.

Fallon & Lucas (1991) argued that employment in formal manufacturing firms would have been 17.5 percent higher in the absence of job security regulations. But not only has the share of informal workers gone up to 93 percent today, the share of informal jobs in formal sector companies is also on an upward trajectory (Papola & Sahu, 2012). In fact, India has been the main driver of increase in informal employment in all of South Asia (Iyer & Vijay, 2013). The immediate reasons for a burgeoning informal economy are increased taxes and social security contribution burdens, intensity of regulations, and low quality of public sector services (Schneider, 2002).

Urgent Need

India is amongst the most difficult places to do business. The World Bank's Doing Business index shows India falling down three places to 134th this year, the worst performing country in South Asia after Bhutan and Afghanistan. Starting a business and enforcing contracts are amongst the major problems (World Bank, 2014). The World Economic Forum's 2014 Global Competitiveness Index ranks restrictive labor regulations as among the top problems for businesses to operate in India. Addressing this could help India make the transition from a factor-driven economy to an efficiency- and innovation- driven economy (Schwab, 2013).

Growth of India's manufacturing sector record is also waning. In the 1970s, the share of manufacturing to GDP was around 12 percent. After barely rising over the years, this share fell again to 14.6 percent in 2012-2013, the lowest in 20 years. To meet the goals of the National Manufacturing Policy (NMP) boosting the share of manufacturing to GDP to 25 percent and adding 100 million jobs--strong labor law reforms are needed now to put India on the path to create around 110 million jobs by 2025 (Goldman Sachs, 2014). With more than 10 million Indians entering the job market annually, the stakes to reform sooner rather than later will be particularly high in the coming decade to exploit the opportunities from the demographic dividend.

Current Organization of Labor Legislation

The Centre failed to make a case for flexible labor markets due to strong trade union resistance (and political party affiliations) and problems with re-drafting amendments. To curtail this, there is a tendency on the Centre's part to pass the buck on to States (Debroy, 2012). India's labor legislation is a subject in the Concurrent List, which means that both the Centre and the State could enact laws pertaining to the relevant category. There are:

* Labor laws enacted and enforced by the Central government

* Labor laws enacted by Centre but enforced by both Central and State governments

* Labor laws enacted by the Centre but enforced by the State government

* Labor laws enacted and enforced by the various State governments which apply to respective States (Ministry of Labor and Employment, 2011).

The following items related to labor appear under the Seventh Schedule (Article 246) of the Constitution, under the Concurrent List, allowing State governments to amend some Central statutes, and also add new statutes to a certain extent:

  1. Trade unions; industrial and labor disputes

  2. Social security and social insurance; employment and unemployment

  3. Welfare of labor including conditions of work, provident funds, employers' liability, workmen's compensation, invalidity and old age pensions and maternity benefits

This paper identifies the most ideal reform scenarios in order of importance but also rates their difficulty level.

Most Difficult Scenario

While India needs a major overhaul in labor legislation, the IDA of 1947 warrants reform most urgently. Bhagwati & Panagariya (2013) highlight some of the pressing changes required that include tightening the definition of retrenchment and deferring disputes to independent authorities to deliver time-bound justice as opposed to labor courts and tribunals. Section 9A should be amended to give the employer more flexibility to reassign workers to similar but alternative tasks at short notice should the need arise. The IDA also prohibits strikes only by public utility services without notice, but such restrictions should also be extended to other industrial establishments to discourage "wildcat strikes." And perhaps the most crucial reform of all is to Chapter V-B that restricts laying off workers in a factory with 100 or more workers (Bhagwati & Panagariya, 2013). Besides India, Pakistan and Sri Lanka are the only countries that require approval by public administration before undertaking any dismissal (Iyer & Vijay, 2013). The Contract Labour Act and Factories Act also need to relax their caps on restrictions.

However, the Labour Ministry in New Delhi rejects any idea of reform on the pretext it would only apply to the 7 percent in the formal sector anyway. On the contrary, the discussion should be about how to bring the 93%...

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