India's manufacturing under-performance Part 2: New clue from multi-plants

In multi-plant units, flexibility in hiring & firing labour comes from fact of having many plants. In single plants, there is no such flexibility, which renders use of contract labour more important

In Tuesday’s piece, we highlighted the rise of the multi-plant phenomenon and showed that when account is taken of it, large plants in India have not grown over time despite a number of favourable developments such as policy liberalisation and contractualisation of labour. We also documented their lower productivity, which could explain in part why Indian firms did not become competitive internationally, especially in labour-intensive sectors.

The next obvious question that arises is this: Why do we see the proliferation of multi-plants in the first place? One explanation is that land is difficult to acquire in contiguous parcels to sustain large plants. Another is that smaller plants can be closer to geographically dispersed labour pools, especially of women. The intriguing third possibility we explore in our recent paper is that firms proliferate plants in order that each plant can remain small. In economics jargon, the extensive margin increases so that the intensive margin does not have to.  

A few pieces of evidence are instructive. Rising contractualisation of labour — from about 22 to 41 per cent over the first two decades of this century — has been an important response of Indian firms and their management to the regulatory environment. Firms such as TeamLease act as brokers, taking upon themselves the burden of complying with labour laws so that manufacturing firms themselves do not have to.

But somewhat puzzlingly, we find that contractualisation is lower in labour-intensive industries than in non-labour intensive ones. This is puzzling because if contractualisation is a response to labour laws and their burdens, the incentives to do so should be greater in labour-intensive industries. For example, in labour-intensive industries, the share has risen from about 23 per cent to 31 per cent over two decades, but in other industries from 19 per cent to 47 per cent.

Unpacking this further, we find that recourse to contractual labour is greater in single plants than multi-plants. We also find that at the margin, the incentive to substitute contract labour for full-time employees rises with employment size in single plants but does not do so uniformly for multi-plant units. Both of these findings are illustrated in the accompanying graphics.

One explanation is simply that in multi-plant units, flexibility in hiring and firing labour comes from the fact of having many plants. In single plants, there is no such flexibility, which renders the use of contract labour more important. We were told by the CEO of a large exporting firm that in the event of, say, a drop in orders from one client that affects one plant, the firm can redeploy labour in another plant without having to terminate their employment, which would be the only option in a single plant establishment. In other words, multi-plants and contract labour are both devices that increase flexibility but in different ways and for different situations and work as substitutes.

According to the CEO, it would be more competitive internationally if its plant sizes could be greater. But it chooses not to grow as a matter of diversifying policy and legal risks and because of onerous regulations. The risks may not be the law per se but stem from the broader political environment in which the firm feels it would be vulnerable to the whims of the Centre and state governments, and also to labour in the event of frictions or disputes.

A dispute in a big plant would entail greater risks relative to that in a smaller plant: In an extreme situation shutting down a plant with 500 employees is less costly than one with 5,000 employees. Risk spreading in an uncertain political and regulatory environment is one reason why manufacturers chose not to become too big.  

The accompanying figure is also important in another critical respect. All the results in our paper show that plants in India try and remain small, but at all points in the employment distribution and not just around the thresholds in various laws.  The desire for flexibility either via contract labour or via recourse to multi-plants exists all along the employment distribution well above the 100 worker threshold (300 in some states, such as Rajasthan and Andhra Pradesh) that has been the focus of nearly all the academic discussions and debates.

The constraints imposed by the thresholds in the Industrial Disputes Act are not the only deterrents to scaling up; it is the pervasive uncertainty in the business and regulatory environment that seems to compel firms to fragment their operations regardless of scale. 

Whether this risk is seen as originating in democratic politics, capital-labour relations or in the broader operation of the law is unclear. But the consequence is that entrepreneurs choose to remain small and choose to forego the benefits of scale and the attendant global export opportunities.

Finally, there are glimmers of hope on the horizon. Driven by the opportunities presented by the “China plus one” developments, Tamil Nadu in particular has witnessed a wave of new investments. What is distinctive about this wave is scale with employment size in the electronics, apparel, and footwear sectors now reaching upwards of 10,000 in selected cases. For example, a Foxconn plant in Sriperumbudur, outside Chennai, employs about 18,000 workers and a Tata plant in Hosur about 40,000 workers. Whether this marks the beginning of a broader, India-wide trend remains to be seen.
 

For the past two decades, however, the reality has been sobering — an economy characterised by small-scale, fragmented operations despite overall dynamism — masked by incomplete and often flawed understanding of the data.
 

Academic and policy discussions in India have been preoccupied with why Indian plants are small with heated debates about whether specific labour laws, especially the Industrial Disputes Act, and the thresholds in them have played an important role. It is time to shift the attention to ask not why plants are small to why they are not large, very large. India does have large plants that operate well beyond thresholds in any of the labour laws. But there are not enough of them; and even those that exist are too small by international standards, both of which undermine India’s manufacturing competitiveness. Understanding why that is so merits further research. The undocumented phenomenon of multi-plants offers one clue in this regard.

Abhishek Anand is Visiting Professor, Madras Institute for Development Studies (MIDS), Arvind Subramanian is Senior Fellow, Peterson Institute for International Economics and Naveen Thomas is Professor OP Jindal Global University. This piece is based on their latest MIDS paper: https://www.mids.ac.in/assets/doc/WP_244.pdf.