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Pranab Bardhan: The vexed issue of labour laws

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Allow more flexibility in hiring and sacking along with reasonable unemployment compensation, says

It is well known that India has not yet succeeded in a massive expansion of the kind of labour-intensive manufacturing jobs that have transformed the economies of China and Vietnam. Most of the success stories of Indian performance have been mainly in skill- and capital-intensive sectors. Among the reasons, most people agree on the problem of inadequate long-term finance for small- or medium-sized manufacturing firms or of infrastructural deficiencies in India. But the reason on which there is a great deal of disagreement relates to labour laws. Many economists and businessmen point to the debilitating effects of their rigidity, which do not afflict China or Vietnam. The labour laws (particularly Chapter V-B of the Industrial Disputes Act) make it very difficult to sack workers in large firms even when they are inefficient (or when the market in some line of production declines) or even to redefine the job description of a given worker, or to employ short-term contract labour; this discourages new hires by employers, induces capital intensity in production, and inhibits entry and exit of firms and restricts the benefits of economies of scale when a small firm contemplates expansion. The adverse effects of the labour laws are particularly visible, critics point out, in the textile and garment sector where Chinese success in recent years has far outstripped that of India (a country with a long history of textiles).

Others have pointed out that the impact of this policy is somewhat exaggerated. In textiles, there are clear economies of scale in spinning, but not so much in weaving, printing and garments. That production scale did not matter in weaving and garments is evident from Japanese and Taiwanese experience in the past where textiles firms were small, but were supported by large trading houses that secured economies of scale in marketing. The Chinese textile firms used to be state-owned and large, but now mostly under joint venture and foreign ownership, they are relatively small. Chinese data suggest that nearly 60 per cent of total sales and export in the garment sector is produced in relatively small firms, though the average size is smaller in India.

There is, however, some evidence on the basis of detailed econometric analysis of ASI data that the states in India with more inflexible labour regulations have experienced slower growth particularly in labour-intensive industries—see, for example, the Journal of Comparative Economics 2009 paper by Ahsan and Pages, or the India Policy Forum 2009 paper by Gupta, Hasan and Kumar (Bhattacharjea in his EPW 2009 paper has, however, pointed to some flaws in the measurement of the index of labour regulations in these and earlier exercises, particularly in view of the differential judicial and legislative interventions in different states and their implementation with varying lags).

Of course, the matter is complicated by the fact that some state governments connive at labour law violations. (In the current downturn in labour-intensive exports, when nearly one million workers quickly lost their jobs, one wonders if this was from small firms below the labour law limit.) There is also a selection bias in the survey data, since labour laws may have discouraged entry of potential firms. In any case there is no study that conclusively shows that any adverse effect of labour laws is particularly large compared to the effects of other constraints on labour-intensive industrialisation like inadequate long-term finance for small firms or those of deficient infrastructural facilities (power shortage, for example, hits small firms without generators particularly hard). If labour laws were the binding constraint, one would have expected firms bunched up near about the 100-employee limit in the job security regulation (the limit for permission for closures in UP is 300 employees), yet in the garment industry NSS data show that the bunching is elsewhere, about 90 per cent of employment is in enterprises that employ fewer than eight workers.

The labour market may be more ‘flexible’ in China than in India (ignoring the hukou restrictions on migration), but one should not exaggerate the difference in the impact of job security and benefits over the last quarter century. Until the late 1990s the government tightly restricted the dismissal of workers in China. Enterprises could dismiss no more than 1 per cent of their employees each year, were barred from dismissing certain types of workers, and were expected to place dismissed workers in new jobs. Then at the end of the ’90s came the large-scale layoffs from state firms. But even during these massive layoffs a significant fraction of unemployed workers (nearly half in the case of older workers) had access to public subsidies (including post-layoff xiagang subsidies for three years followed by unemployment benefits, and social assistance through the minimum living standard programme). Since January 2008 a new labour law in China partially secures the tenure of longtime workers, but not so rigidly as in India.

The Indian trade unions, both on the left and the right ends of the political spectrum, have been hostile to any labour reform, and that is why politicians have put it on the back burner. At a time when companies are often trying to curb the workers’ basic right to form unions, unions will be particularly edgy in discussing labour reform. There is, of course, too much attention paid to the job security part of labour laws. One can start with reforming some other labour laws, like those relating to the ease of formation of unions (any seven people can start a union) and lack of secret ballots in union decisions — these, instead of protecting labour, actually keep the labour movement weak and fragmented. On job security there has to be a package deal: allowing more flexibility in hiring and sacking has to be combined with a reasonable scheme of unemployment compensation or adjustment assistance, from an earmarked fund to which employers as well as employees should contribute. No Indian politician has yet gathered the courage or imagination to come up with such a package deal.

The author is Professor of Economics, University of California at Berkeley

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