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(Photo: Bloomberg)
(Photo: Bloomberg)

Opinion | Markets work better for workers than regulations do

Economists support dismantling stringent labour regulations because it would result in more jobs. Then why is there so much opposition? There are three reasons

Economists frequently argue that labour laws in India have had disastrous consequences. They make it very costly, on the margin, to formally hire workers. In response, employers use more capital, a trend we see through a relatively low share of labour in gross domestic product. Or, employers circumvent regulation in perverse ways, like having contractors hire workers instead of directly employing them. This has created a two-tiered labour system—a small group of formal, often unionized, workers, who get protection through regulation and cannot be fired easily, and a large (90% by some estimates) unorganized pool of labour, which does not get most of these protections. Even the limited shield they could have got, through a direct (though lopsided) contract with their employer, is not available to them. There is evidence backing both these trends. Economists support dismantling stringent labour regulations because it would result in more jobs. Then why is there so much opposition to these economists? There are three reasons.

The first reason relates to the way most workers are treated in the country’s unorganized sector: long hours, lack of safety, poor treatment of women, lack of restrooms, etc. In comparison, the small but formal sector looks great. The typical response has been to legislate the problem away, and mandate, often with criminal penalties, that employers follow these rules. But this only treats the symptom, and not the problem.

The problem needs to be restated as one of demand and supply—wages are low and workers are treated poorly because there are too many workers, mostly unskilled, trying to get too few jobs. This is not the fault of workers, but the consequence of a terrible education system and 70 years of bad economic policy, which has trapped most Indians in poverty. Consequently, employers find workers easily substitutable; they treat them badly, as less than human in some cases.

The well-intentioned are sceptical of the market because contracts may be lopsided, to the disadvantage of workers. But there is only one permanent solution to this problem—more jobs. This would give workers more options, which is the only way to discipline badly-behaved employers. Instead, we have tried suppressing and legislating our way out of market reality. Laws against market forces misalign incentives and create corrupt inspectors and middlemen, as witnessed in the past. Instead, economists suggest using market forces to discipline bad players.

This brings me to the second reason for the disagreement—splitting versus growing the pie. There is a legitimate question over the sharing of any surplus between workers (suppliers of labour) and employers (that demand labour). The typical solution is to split the pie more equitably through legislation. But sharing this surplus has to do with bargaining power, which depends on choice, competition and substitutability. Demand for labour services in India is highly responsive to prices (or wages). In small firms, the cost of labour (wages+cost of compliance) is a large proportion of total costs, so the demand for labour is highly elastic. In larger firms, demand is elastic because capital can be more easily substituted for labour. This highly elastic demand for low-skill labour, coupled with a very large supply of poor and unskilled workers, is the reason for workers’ low bargaining power. It has little to do with mal-intentions and class struggles, though it is often seen through these prisms. Those who worry that deregulation would lead to a lot of new unregulated firms entering the market should also understand that it will create jobs and inadvertently provide a different kind of regulation, through increased competition and choice. But most importantly, there will be a larger surplus to split, because the size of the pie will likely get bigger and create more jobs—to the benefit of workers.

The third disagreement is over agency. Those who demand legislation to protect workers are also taking away their agency. The standard explanation is that workers are poor and illiterate, don’t have bargaining power, make bad choices, and need protection. The core assumption of economic thinking is that when individuals make a choice, they pick the better option among the available choices. One need only look out of one’s window to recognize that India’s poor and marginalized workers have terrible choices. But, when they choose to work in these awful conditions, they are still choosing their best option, given the alternatives. India’s poor are smart and resourceful, they work incredibly hard to survive, and given an alternative way to improve their lives, they would be the first to take it. The problem is not that they make bad choices, but that they have a bad and limited choice set. Our effort should be to increase the choice set, which cannot be done through legislation but only through more jobs and economic growth, coupled with improving their choice set through efforts to create a strong contract-enforcement system.

Finally, with the contraction of India’s economy and an unemployment rate pegged above 25%, deregulation will create a huge pool of desperate workers willing to work at low wages and unfavourable conditions. The way to solve this problem is not through more labour regulation, but unconditional income support for the poor. Income support will save workers from making desperate and unsafe choices without distorting the country’s labour market, as so many old regulations have done.

Shruti Rajagopalan is a senior research fellow with the Mercatus Center at George Mason University, US.

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