Labour restrictions: Breaking six decades of deadlock

Initiatives to push the dynamics in the labour market to force regulatory practices to adapt to evolving economic and socio-political structures.

India suffers from one of the most rigid labour markets in the world. The 1991 reforms liberalised the economy to some extent, but labour regulation continues to remain archaic, restrictive, and convoluted. As a result, while growth rate quadrupled, the rate of good quality jobs has remained stagnant. The costs imposed by labour regulation force businesses to remain in the informal sector, where regulation is lax or absent and social protection programmes are limited. As a result, 93 percent of the Indian workforce derives their livelihoods from the informal sector — making economic modernisation, and in turn, generation of good-quality livelihoods, a distant goal.


A quick look at growth versus employment post-1991 brings out the inconsistent relationship between the two: As growth rates increased from around 3.5 percent to 6 percent between 1991-2000, employment growth fell from 2 percent to 1 percent in the same period. The situation improved in 2000-2005 when India’s growth rate averaged 7 percent, and employment went up by 1.6 percent. But as a U-turn, in 2005-2010 when growth averaged higher at 8 percent, employment dropped by 5.4 percent, as per World Bank figures.

The rate of good jobs creation has also suffered, as per data from CRISIL. For instance, in 2005-10 compared to 2000-05, the number of casual (informal) jobs rose substantially, from 8.6 to 21.9 million. But regular jobs dropped from 18.6 million to 5.7 million. However, the self-employed took the biggest hit with a drop of 25 percent in 2005-10 compared to 2000-05. In short, 92.7 million jobs of better quality were added in 2000-05, compared to the 2.2 million increase in 2005-10, mostly composed of casual jobs. This, of course, saw the continuing enlargement of the informal sector to 93 percent today.


On the other hand, formalisation – and larger firms – is associated with higher productivity, innovation, and competition for exports. But of course, most Indian businesses cannot avail of this opportunity owing to disincentives of moving to the formal sector. However, formalisation is not desirable until labour laws are relaxed, statutory costs decline, and service quality of social security organisations is improved.

Analysts and policymakers have debated the challenge of inflexible markets in India for decades. Recommendations often proposed drastic measures that have met with staunch resistance from parties whose interests are vested in an inflexible labour market — including employees, trade unions, and the labour ministry. However, in the face of challenges such as falling growth rates, rising fiscal and current account deficits, and a stagnant or declining manufacturing sector, less sensitive labour market reforms merit urgent consideration. A workable set of initiatives in the following three areas — by accounting for those in favour of status quo and others who favour immediate reform — could result in better outcomes.

The first area concerns increasing contestability in the labour market. Initiatives are needed to identify clearly the difficulties in scaling up social security in the informal sector. Currently, the schemes under the Employment Provident Fund Organisation (EPFO) make no economic sense – they are not only expensive, but also offer substandard services. Interests of poor workers take the biggest hit with almost 50 percent of their monthly wages channelled towards the EPFO. With low perceived value, tendency for poor employees to avoid the EPFO is higher. There is also evidence of collusion between employers and labour inspectors to avoid extending these options at all to employees – for bribes lower than the required value to be matched by the employer. Two reforms are needed – First, reform the EPFO and protect contract workers. Competition from the newer National Pension System (NPS) could force EPFO to reform. Unlike the EPFO, it offers a defined contribution, higher rate of return, is web-enabled, and well regulated, but employers need to extend this option. The government could also look into investing in private companies whose services are similar to Team Lease and Randstad, whereby contract labour can be protected by security provisions. Aadhar-linked benefits transfers could play a role simultaneously. These small reforms can reduce the trade-off to stay informal – but in the interim, states should focus on creating sustainable, productive, livelihoods that are based on the main drivers of growth, including the application of knowledge economy.

The second area involves devolving more power to the states. Currently, labour regulation lies in the Union List, with some other sub-items – trade unions, social security, and working conditions – on the Concurrent List. It would make more sense to move these to the State List so that states can exercise freedom over contextualising legislation around their own economic and political structures. There is increasing evidence from the 2012 Labour Bureau report: states that amended their legislation in further pro-worker directions lost out on industrial production, compared to those who improved on the same. This fits with Bibek Debroy’s warning that federal freedom could be used irresponsibly. However, there is a stronger probability that increased federal freedom could force states to modernise labour laws as development becomes increasingly important to voters, especially young job seekers. Competition from differentiated labour market dynamics could nudge states in the desired direction — as reflected by indices such as the Teamlease labour ecosystem index or Cato’s economic freedom in Indian states.

The third area highlights the importance of substantive dialogue among stakeholders. Trade unions often view reforms as a dilution of their rights. While this may be true in some cases, it may also be that they do not fully understand the long-term implications of reforms. It is important to balance flexibility with security. Though ‘flexibility’ is a threatening term for unions, their perceived severity could be reduced by clearly unbundling different degrees of flexibility and enforcing them. For instance, layoffs and retrenchment with adequate benefits are more palatable to the trade unions and political parties than closures — thereby making it easier to sell such reforms. It has been speculated that if compensation for layoffs and retrenchment were increased from 30 days’ pay per year worked to 45 days, political resistance may diminish. Higher severance packages could be more acceptable to unions, offer greater flexibility to business, better policy design, and lower transaction costs for new companies. Furthermore, employers should take initiatives to make union bargaining unnecessary by investing in community development measures, work benefits, timely breaks, and better work conditions – successful approaches by large construction companies in India. Under the new Companies Bill, compulsory spending on community development will be a step forward in this direction.

This is not a comprehensive package of reforms but a combination of suggested initiatives to push the dynamics in the labour market to force regulatory practices to adapt to evolving economic and socio-political structures – as without adaptability welfare cannot be advanced. Even if it is the intention of the government to reform in this area, selling those reforms in a way that fully compensates the short term “reform losers” is an extremely difficult task. It is time we start a nuanced discussion on how to develop the labour market: to think about initiatives in the three above areas, which are compatible with the current political economy, and include the informal sector in the reforms dialogue – to create a better climate for future reforms in the labour market. In the face of sluggish growth rates, rising fiscal and current account deficits, and a demographic dividend that could be exploited, India’s political elite must remember that boosting good quality jobs is a matter of top priority for social cohesion and economic stability.

This piece is a part of the research report, ‘Towards greater labour market flexibility: Issues & Options’ for the Takshashila Scholars Programme.

Photo: Water Lemon