Why labour law dilutions may not bring in fresh investments3 min read . Updated: 29 Jun 2020, 09:14 PM IST
Across India, firms themselves cite bigger constraints, such as access to markets and inputs, than labour market regulation
Few issues in India are as polarizing as labour law reforms. As several states recently announced changes to their labour laws, critics slammed them for exploiting workers while proponents saw them as long-needed moves that would unleash economic growth. Data and research, however, suggest that labour law reforms on their own may not be enough for growth because labour is not the biggest constraint holding back firms and investment.
According to the 2014 World Bank Enterprise Surveys (ES), a survey of 9,281 firms across India, less than 5% of firms identified labour regulation as a primary obstacle to their operations. This number has barely budged since the 2010 ES round. Meanwhile, at least five other factors were cited as primary obstacles more frequently by firms across India, from corruption to tax rates to access to finance.
Even more recent data from an enterprise survey carried out by NITI Aayog and the IDFC Institute corroborate this point . In that survey, a number of other obstacles are identified more often by firms in India as a major or very severe constraint. These include permissions for setting up a business, obtaining land and construction permits, and others.
Of course, only a few states--namely, Uttar Pradesh (UP), Madhya Pradesh (MP), and Gujarat--recently announced major labour law changes (which are pending due to intervention from the Centre), and one might wonder if these states in particular are in need of labour law reform. The ES data indicates labour regulation is not even a top 3 concern among firms in UP and MP--states that have strong ambitions to attract investment in industry--and is the second-most concern in Gujarat, already one of India’s industrial powerhouses.
There is large variation across states in terms of industrial output, investment attraction, and productive job creation, and this variation is likely explained not simply by differences in labour regulation but also by differences in other elements that influence competitiveness. More flexible labour laws only go so far if you cannot transport your products to markets and to ports cheaply, if you cannot access raw materials and inputs easily, and if you cannot find workers with the skills you require.
A limitation of such survey data is that they only cover firms that are already operating in India. One could argue that labour regulation is actually a bigger constraint than it appears, because the firms already operating in India may be precisely those firms that are less affected by stringent labour laws--which would explain why they cite them infrequently as an obstacle. Since one of the stated purposes of the aforementioned labour law changes is to attract foreign investment, particularly from firms exiting China, understanding the priorities and perceptions of potential foreign investors is important to address this gap.
According to the World Bank’s Global Investment Competitiveness Survey from 2017, a survey of 754 multinational companies investing in developing countries, 86% of foreign investors cite a business-friendly legal and regulatory environment as either critically important or important for their decision to invest in developing countries. Note that this factor is much broader than only labour regulation. Although stringent labour regulations are likely to increase labour costs, only 53% of foreign investors cite the low cost of labour as either critically important or important for investment decisions--much lower than the 74% that cite labour skills as critically important or important.
Looking at foreign investors’ interest in India in particular, inflexible labour laws rank 5th among the 5 least attractive factors--behind transport and logistic infrastructure, the legislative and administrative environment, corporate taxation regime, and overall ease of doing business. Corroborating the aforementioned World Bank survey, the most attractive factors about India are competitive labour costs, good labour skills, and the large domestic market.
On top of this data, research on the impact of labour law reforms in India has yielded no clear conclusion (). What we do know from research on economic complexity though, is that no reform in isolation--including labour law reform--is a panacea for economic growth and job creation. And more than specific reforms, investors value policy certainty. Not only are the latest reforms riddled with legal uncertainty, they are also just 3-year changes. This may not be long enough to attract the large, long-term investments that deliver jobs. To attract such investments, state governments may need to pursue deeper reforms that tackle the constraints that firms feel more acutely.
The authors are development professionals.