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Business News/ Opinion / Labour law reforms are a necessity

Labour law reforms are a necessity

It is ironical that a country with so many unemployed youths mostly exports capital-intensive goods

Photo: Hindustan TimesPremium
Photo: Hindustan Times

While it is heartening to note that Indian policymakers seem to have realized the importance of manufacturing in providing jobs, it is also equally important to realize that the path leading to higher manufacturing employment has to necessarily cross a difficult bridge called labour reforms. Careful research done by several leading economists using nationwide plant-level data and also employing cutting-edge econometric techniques has shown that labour reforms is sine qua non for achieving employment growth in India.

Given its criticality, the issue of labour reforms has attracted a lot of mainstream media attention. However, most of the arguments advanced, both in favour of and against labour reforms, are coloured by the ideological worldview or the economic status of the people making the arguments. Many a time, arguments are driven by passion rather than reason. For example, all those who represent workers or subscribe to a leftist worldview believe that labour reforms are likely to have a detrimental impact on employment and hence oppose even simple procedural reforms in this area. On the other hand, industrialists and those subscribing to rightist worldview call for radical labour reforms without appreciating the plausible political consequences and immediate human costs.

In order to understand the real impact of labour reforms on employment growth, it is important to move beyond self-selected anecdotes and engage in careful empirical analysis. Fortunately, a number of prominent scholars have taken up this task and produced a wealth of evidence regarding the association between labour reforms and many real outcomes such as employment growth, firm growth, plant productivity, etc. Almost all of them use the data provided by Annual Survey of Industries (ASI) compiled by the ministry of statistics and programme implementation. The survey provides plant-level information pertaining to inputs used and output produced by thousands of factories. More importantly, the survey is conducted every year—allowing the researcher to track the growth of a factory over the years.

Professors Timothy Besley and Robin Burgess (BB henceforth), in their seminal research paper published in the Quarterly Journal of Economics, examine if labour regulations hinder economic performance in India. They examine all the state-level amendments to the Industrial Disputes Act, 1949, made between 1949 and 1992. They carefully construct an index of changes by classifying all the amendments into those that ease labour laws and those that further tighten them. Using the plant-level ASI data described above, they relate the labour law index to plant-level outcomes such as employment, productivity and output. They find that rigid labour laws lead to significant reduction in employment, productivity and growth. More importantly, they document a strong relationship between labour laws and urban poverty. In other words, rigid labour laws are also associated with increased urban poverty. BB conclude that rigid labour laws ultimately end up hurting the very same constituency that they are supposed to protect.

To illustrate their point, BB compare manufacturing growth in West Bengal and Andhra Pradesh during their sample period. West Bengal, which was the largest producer of manufactured products during the beginning of their sample period, experienced a negative 1.5% growth in manufacturing, whereas Andhra Pradesh experienced a positive growth rate of 6%. Interestingly, as per the labour law index constructed by BB, West Bengal further tightened labour laws, whereas Andhra Pradesh liberalized them.

One of the limitations of BB is that they look at only amendments made to the Industrial Disputes Act and ignore other important labour reforms. Another criticism stems from the fact that BB ignore industry level heterogeneity in terms of labour orientation. Sean Dougherty, Verónica Robles and Kala Krishna (SVK) conduct a comprehensive study which overcomes the above mentioned weaknesses. Apart from the Industrial Disputes Act, SVK look at formal and informal labour market reforms in seven additional areas: the Factories Act, the State Shops and Commercial Establishments Acts, the Contract Labour Act, the role of inspectors, the maintenance of registers, the filing of returns and union representation. More importantly, they distinguish between labour-intensive and capital-intensive firms. The idea here is that if the negative impact pointed out by BB is due to rigid labour laws, then the impact should be higher in industries that are heavily dependent on labour. They indeed find such a result. They also find that the negative impact on growth and productivity is higher for firms in industries that face a lot of volatility. This is understandable given such firms require a lot of flexibility. Similar results have been obtained on studies done on other countries such as Mexico and Brazil.

Given the rigidity of labour laws, it is not surprising that the share of manufacturing in India’s gross domestic product has stagnated between 14% and 18%. A close look at the composition of exports further points out the distortionary impact of labour laws. It is ironical that a country with surplus labour and a large number of unemployed youth mostly exports capital-intensive goods such as petroleum products, gems and jewellery, transport equipment, machinery and instruments, and pharmaceutical products.

Given the current political and economic scenario, it is very difficult to expect a political consensus emerging at the national level. However, states such as Rajasthan, Madhya Pradesh and Gujarat have made positive moves with respect to labour reforms. Given the emerging competition between states to attract investments, one may hope that other states also are likely to follow suit sooner rather than later.

Prasanna Tantri is senior associate director at Center for Analytical Finance, Indian School of Business.

Comments are welcome at

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Published: 22 May 2016, 11:48 PM IST
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