India's perpetual job crisis might find its fix in labour reforms

The lack of jobs is beginning to haunt the Modi government. The Reserve Bank of India's recent Consumer Confidence Survey shows that public perception is also beginning to take account of the fact that there are no jobs available in the economy. According to the survey, 43.7 percent of responders felt that the employment situation had worsened as compared to 31.9 percent a year ago.

The official unemployment numbers, which hover at around five per cent, will never reflect the true picture since, in a developing economy, where poverty is high and unemployment benefits are virtually non-existent, no one can afford to remain out of the workforce for long. They usually find employment doing odd jobs or in the agricultural sector.

However, job creation numbers do give a clearer picture. According to the Labour Bureau, the Indian economy was generating around 900,000 jobs in 2010 and 2011. Since then, the jobs created in the economy have consistently fallen, reaching around 135,000 in 2015 as opposed to the need for an annual generation of over 11,00,000 jobs. The situation has not improved since.

However, this is not a recent phenomenon. The Indian economy has never been good at creating jobs. As per popular estimates, including those of the RBI, India's employment elasticity, which is a measure of the percentage in employment for a one percent change in economic growth, has been around 0.2 in the post-reform period. This implies that as the real GDP rises by 10 percent, employment will merely rise by two percent. To put things in perspective, International Labour Organisation (ILO ) estimates Brazil's employment elasticity to be an impressive 0.9.

This long-term trend shows that there is a structural reason behind this problem. When an economy transitions from agricultural-led to a modern one, it undergoes three key transformations: Movement of labour out of agriculture into industry and then services, shift of workers from informal into the formal sector and finally a rapid pace of urbanisation as more industries are set up in the rural areas around cities.

India has missed the bus on all three of these fronts. Industrial development never took place in India and the economy became service-led right away. Employment in industry and services remains predominantly informal. Consequently, the pace of urbanisation has slowed in India.

Moreover, whatever industrial development has taken place in India has been either capital-intensive or skilled labour-intensive. India's labour-capital ratio in a vast majority of industries has been lower than other countries at similar levels of development. The very opposite is needed for job creation in a developing economy. But why has the pace of development been so skewed for India? What is so different about India that made it deviate from the historical trend of structural transformation for economies around the world?

India's notoriously rigid labour laws are the leading cause behind these anomalies. Labour falls under the concurrent list of the constitution, which implies that both the Centre and the states can form laws on it and neither has been miserly about this. When combined, each state ends up with over 200 different labour laws. These disincentivise firms from growing beyond a point. For instance, the Trade Unions Act of 1926 requires firms with seven or more workers to form trade unions. The Factories Act of 1948 mandates manufacturing units with 10 or more workers to have several working hour limits and workplace conditionalities that become stricter with more workers.

The most burdensome of all is the Industrial Disputes Act (IDA) of 1947, which covers all industrial disputes and makes it almost impossible for firms with 100 or more workers to fire anyone. Establishments require permission from the labour department to lay anyone off and such permissions are rarely given even if the firm is unprofitable. Therefore, firms with six or less employees have the most labour flexibility.

As an expansion of firms comes with high legislative costs in India, it is rational for them to remain small. This is why 84 per cent of manufacturing employment is restricted to micro and small enterprises in stark contrast with other developing countries (46 per cent for South Korea and Thailand, 27 per cent for Malaysia and 25 per cent for China).

India's labour laws have inhibited the growth of manufacturing firms, which lose out on the gains they could have made from economies of scale and innovation. Due to these reasons India has not been able to undergo industrial development and is finding it difficult to gain from the rise in labour costs in China. India could have been the next manufacturing hub after China but since there is a sheer lack of capability; countries like Bangladesh and Vietnam have been thriving in labour-intensive sectors like textiles.

Labour reforms are, therefore, the antidote to India's perpetual job crisis -- but this is a politically sensitive topic. The Modi government is in a unique position of being capable enough of pushing through such bold reforms since it has the numbers needed for this. However, considering how most of its attempts at reform have backfired, this will be the farthest thing on the government's mind. A piecemeal attempt at labour reform with the Small Factories Bill, which aims to exempt factories with 40 workers from 14 labour laws, has been in limbo for the last two years.

However, on a positive note, some state governments are beginning to allow larger firms to retrench workers without seeking permission with their own amendments to IDA. Hopefully, it will not be too late before India manages to extricate itself from this mess of its own creation.

(Amit Kapoor is chair, Institute for Competitiveness, India. The views expressed are personal. He can be contacted at amit.kapoor@competitiveness.in. Chirag Yadav, senior researcher, Institute for Competitiveness, India has contributed to the article.)