Indian Economy, 5th edition (100 page)

Reducing Attractiveness of Staying Small:
Growing bigger is unattractive in India because some of the benefits targeted at MSMEs are withdrawn while some new regulations and obligations come upon them. Innovative approaches are needed for giving MSMEs the incentive to grow. For instance, new regulations could be kept in abeyance for a period after the MSME crosses the size threshold that would require it to meet the regulation.

II. LABOUR REGULATIONS

India has a number of labour practices that, economists have argued, further impede the creation of productive jobs in the largescale organised sector. There exists considerable variation in hiring practices across firms of different sizes in India. A recent study
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finds that the job creation rate is much bigger for small firms than for large ones; on the other hand the job destruction rate is higher in large firms, with the result that the net employment rate in large firms is negative and strikingly smaller than in small firms.

In the same way, organised industry creates few jobs compared to unorganised industry (which is dominated by small firms). Growth in unorganised industry jobs in 2009-10 is primarily explained by a dramatic growth in construction. Based on data from National Sample Survey Organisation (NSSO) surveys, employment in construction increased by 70 per cent between 2004 and 2009. One recent development is the significant pickup in growth of the organised industry sector jobs in 2009-10. However, two points may be of note. First, this growth is characterised by adding mostly to ‘informal’ jobs within the formal sector with little increase in productivity. Second, despite the recent pickup in organised-sector job growth, unorganised-sector employment still constitutes more than 95 per cent of overall industry employment; specifically within manufacturing, unorganised-sector employment comprises 70 per cent of overall employment.

Why mo
re jobs are not being created by India’s large organised manufacturing?
There are several possible explanations. First, strict labour laws may have hindered the growth of organised large-scale manufacturing. India, the employment protection legislation (EPL) laws are stricter than in all but two OECD countries. However, very few workers are actually covered by these laws. Indeed, India may suffer the consequences of strong worker protection (low flexibility for employers and strong reluctance to offer workers formal jobs) without giving most workers the benefits. Although the direct impact of India’s labour regulations has been a subject of intense debate, there is a substantial body of evidence which suggests that rigid labour regulations have played a significant role in explaining low organised manufacturing output and employment and high informal manufacturing output.

However, some economists dispute the evidence that establishes the importance of labour regulations in determining economic outcomes. In India’s case, one of the first and most frequently cited studies on the topic
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has come under extensive criticism
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. While more work has been done that addresses some of these criticisms, the evidence on the effects of labour regulations outside of India is also mixed. As per the World Bank,
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‘A careful review of the actual effects of labour policies in developing countries yields a mixed picture. Most studies find that impacts are more modest than the intensity of the debate would suggest.’ If labour laws really constrain firms, they would respond in predictable ways:

i.
Relying more on capital instead of labour

ii.
Resorting to informal arrangements/limiting their scale in order to remain outside of the formal sector altogether, and/or

iii.
Hiring contractual labor

The increased use of capital-intensive techniques is reflected in a steeply rising capital/labour ratio for the organized economy.
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This raises the obvious question whether it is justifiable for a relatively labour abundant country like India with low wages to be increasingly resorting to more capital-intensive technology. Of course, as we have argued earlier, countries would use more capital per worker as they get richer, but the capital intensity is higher and has increased at a much faster rate for large firms than for small firms in India, even while they have created fewer jobs.
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Firms would also resort to informality if labour laws were overly constraining (as has been argued earlier in this chapter). The extent of informality in India stands out relative to countries at similar levels of development (discussed in the next sub-title
‘Informality of Employment in India’
). Roughly 85 per cent of the workforce in India is engaged in the informal sector all of which are unincorporated enterprises operated on a proprietary or partnership basis and with less than 10 employees. The prevalence of informal employment – workers in either the informal sector or in the formal sector but lacking employment or social security benefits is even higher; 95 per cent of jobs are informal and 80 per cent of non-agriculture wage workers work without a contract.

There is
advantage of formal employment
via contracts for worker training and learning, especially if contracts have a significant probability of being rolled over into the long term. Experience is important for skill development. With a paucity of technical/vocational training institutions (say like the
German model
) in India, ‘on-the-job learning’ is one of the easiest and most viable models of human capital accumulation. Employment that is likely to endure provides incentives to the firm for nurturing skill building and to the worker for developing skills. These contracts necessitate
backloading
of pay and incentives (compensation increases with experience) so that workers do not avail of the training and leave. In contrast, informal and temporary contracts are in fact flat and sometimes even
frontloaded
, absolutely the inverse of the desired architecture. Long-lasting employment does not mean tenure for life, which is the other extreme of the contract space commonly found in India. Permanent employment not only limits firm flexibility, it also reduces some workers’ incentives to learn or exercise effort. An intermediate structure that exists in most countries is contracts that allow termination in situations of firm distress or for poor worker performance, but with carefully designed and effective redressal mechanisms if the employee is fired without cause, as well as compensation for severance and unemployment benefits.

Whatever be the causes, the fact is that India is not creating enough productive jobs. Moreover, India has the
dubious distinction
of having some of the most comprehensive labour laws in the world, even while having one of the largest fractions of the working population unprotected. Not only do informal workers have lower productivity and earn less, but they are also more vulnerable to violations of basic workers’ rights such as reasonable working conditions and safety at work. It may be the stringent protection that is afforded by existing regulations that is responsible for both the ‘paucity of good jobs’ as well as the inadequate protection that most workers have. In India, reforms are typically implemented only after they have been subject to a lot of debate and after some sort of
political consensus
is reached on them. It is therefore imperative that consensus building on
labour market reforms
should start soon. India needs many more firms in the formal sector, especially firms that continue growing and creating productive jobs. India may take some ideas from Mauritius as how did it undertake reforms that improved employment.

It may take time to build political consensus for fundamental reforms. In the meantime, states could be allowed more flexibility to experiment without coming into conflict with central statutes. As best practices evolve, success in job growth will resolve theoretical debates more easily than a thousand papers. If indeed, rigid labour laws are determined to be the key constraining factor in the creation of productive jobs. Win-win reforms are easily available. Existing permanent workers can continue till retirement with their privileges left untouched. The remaining workers could be encouraged to move into contractual employment that can be terminated, but which gives the worker some protections including severance pay, unemployment insurance, and the right to reverse unfair dismissal through appeal.

In the meantime, the government should continue to create a minimum safety net for informal workers (in the informal sector and in informal work arrangements in the formal sector) by, for example, extending the reach of national-level schemes such as the RSBY (Rashtriya Swasthya Bima Yojana) and the NPS (New Pension Scheme) and introducing
unemployment insurance schemes
(e.g. Supplementary Unemployment Benefits Fund to be created by automotive companies).

INFORMALITY OF EMPLOYMENT
IN INDIA

The
extent, causes
and
consequences
of informality in India’s employment can be seen by the following way:

i. Extent of Informality

India has witnessed impressive economic growth over the past 20 years, but despite of it, the vast majority of Indian workers continue to toil in informal employment.

•
Roughly 85 per cent of the workforce is engaged in the
informal sector
; even after excluding the agricultural sector, the share of the workforce in the informal sector remains at 70 per cent.
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The prevalence of
informal employment
workers in either the informal or formal sector who lack employment or social security benefits is even higher.

•
While precise estimates of the extent of informal work arrangements are hard to come by, a detailed study by the National Statistical Commission reveals that as of 2004-05, 95 per cent of jobs are informal and these are not limited to the informal sector, even in the public sector, 33 per cent of all jobs in India are informal.
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•
Among wage employees outside of agriculture, more than three-quarters have no written contract, 70 per cent are not eligible for any paid leave, and 74 per cent are not covered by social security benefits. Along all of these measures of informality, India saw an uptick over time.
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•
“While high levels of informality are not uncommon in South Asia, India (along with the rest of the region) stands out from an international perspective. Using lack of pension coverage as a proxy for informal employment, 91 per cent of the labour force in South Asia is informal, surpassed only by Africa. Compared to countries at a similar level of development, India’s very low usage of written contracts for its non-agricultural employees, 80 per cent of whom work without a contract, also stands out. This figure is higher than for, for example, China, Pakistan, Ghana, and South Africa. This is despite the fact that India’s share of employment in the informal sector is roughly in line with that of its peers and confirms the significant prevalence of informal arrangements within the formal sector.”
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ii. Causes of Informality

Informal employment results both from workers being excluded from formal jobs and from workers or firms voluntarily opting out of formal employment.

•
The ‘exclusion’ view of informality emphasises the
dual nature
of labour markets, in which a highly productive formal sector coexists with a subsistence informal sector, which absorbs excess labour.

•
It has been found out through evidence that constraints to the expansion of the formal sector model (such as insufficient capital accumulation and natural resources)
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or overly burdensome costs of registering
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lead to persistent informal employment.

•
As per the ‘voluntary’ view, firms and workers decide on whether to become formal by comparing the perceived costs of being formal with its perceived benefits. In this setting, labour institutions, taxation, and regulations primarily explain the prevalence of informal employment, by effectively increasing the costs of formality. At a cross-country level, countries with more burdensome entry regulations have larger informal sectors.
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The labour laws of India may incline firms to go for informal arrangements, rely more on capital instead of labour, or limit their scale in order to remain outside of the formal sector altogether. This issue has been discussed in the next sub-title
‘Labour Laws as Impediments’
).

iii. Consequences of Informality

The high rate of informality in India is a drag on its economic development and a source of considerable inequity.

•
Productivity differences between workers in the formal and informal sectors are large, suggesting that moving a worker from an informal to a formal firm would bring about sizeable gains from improved allocation of resources.

•
Rough estimates suggest that an informal job in the formal sector has double the value added than an informal job in the informal sector. And importantly, the value added per worker in a formal job within the formal sector is almost ten times that in an informal job in the formal sector. Therefore, loosely speaking, the benefits of moving into contracts within the formal sector are likely to be substantial and significantly higher than the gains from moving an informal-sector worker into an informal job within the formal sector.
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•
Besides earning less, informal workers are also more vulnerable to violations of basic human rights such as reasonable working conditions and safety at work. With little job security and limited access to safety nets, most of the informally employed remain extremely vulnerable to shocks such as illnesses and loss of income. This is why a strong correlation exists between informality and poverty in India.
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