Why India needs labour law reform

By Kaushik Basu Professor of economics, Cornell University

Legislation means Indian workers cannot be fired easily

There is a story of a prospective school teacher who was asked during an interview by the principal of a conservative religious school, "Is the earth flat or round?"

The hapless teacher looked around at the faces of the interviewers for hints and, not finding any, settled for: "I can teach it flat or round."

The trouble with a lot of our economic policy advisers is that they are like the school teacher.

They try to gauge what answers will make them popular with their political bosses and then give them the advice they seek.

This may be good for the advancement of their career but is not good for economics or for the country in question.

What is needed is not freedom for firms to wantonly fire workers but a legal regime whereby firms can write different kinds of contracts with their workers depending on their needs Your views on this column

One area where modern economics has a lot to offer, but what it has to say is not pleasing to the ear, is labour regulation.

In India today, this is the most important area crying out for reform.

An injection of flexibility in labour market regulation can attract foreign capital, create jobs and unleash higher growth.

But reforming labour laws is no easy task.

Chaotic laws

This is one area where what appears to be good is often not so.

The body of legislation that shapes the industrial and labour environment in India is huge.

India is trailing neighbours such as Pakistan in freeing up business

Here is a minuscule sampler: Minimum Wages Act, 1948; Trade Unions Act, 1926; Contract Labour Act, 1970; Weekly Holidays Act, 1942; Beedi and Cigar Workers Act, 1966.

These and much more form a crisscrossing network of chaotic, strangulating, overlapping and often-contradictory laws that are crying out for overhaul.

The single most important labour law is arguably the Industrial Disputes Act (IDA), 1947.

This was enacted a few months before India's independence and guides the hiring and firing rules of the industrial sector and is a good example of a well-meaning policy that is founded on antiquated economics and a handsome misunderstanding of the way markets function.

The IDA makes it very hard for firms to fire workers.

In fact an amendment made to the IDA in the mid-1980s requires that any firm employing more than 100 workers needs to get permission from the state government before retrenching workers (and in practice that permission is seldom given).

This law has probably done more to hold back the growth of India's manufacturing sector than any other policy.

Indian labour laws are among the most rigid in the world

What is remarkable about this and so many other Indian labour laws is that they leave no room for free contracting.

Suppose a firm wants to manufacture a product that has volatile demand - like fashion garments.

This firm may want to offer workers higher wages but make it clear to them that they could be given a month's notice and asked to leave.

Such a contract will have no legal standing because the IDA specifies in advance how and when workers may and or may not be retrenched. Hence we do not see such contracts.

At first sight this law looks like a kind piece of legislation that protects the jobs of poor workers.

Non viable

What this popular view misses out on is the fact that this law also keeps hundreds of thousands of workers unemployed because firms, wary of the fact that they will not be able to offload them, do not hire in the first place.

Also, in areas of volatile demand, many firms have not even come into existence because they realise that India's current legal regime makes them non viable.

It is not surprising at all that labour data from the '80s show that the number of people employed in firms of size greater than 100 workers has gone down.

This is the market's natural response to the amendment in the mid-'80s.

What is needed is not freedom to firms to wantonly fire workers but a legal regime whereby firms can write different kinds of contracts with their workers depending on their needs.

One firm may offer a low wage and life-time guarantee of work and another a high wage and very short notice to quit.

Rigid

Some recent data compiled by the World Bank collate the level of rigidity of hiring and firing rules in different nations -100 being the score of the highest conceivable rigidity.

India is among the most rigid countries with a score of 48.

China has a score of 30, Korea 34, Norway 30; Singapore close to 0.

Reforming labour laws will boost industry and create more jobs

The fact that the less rigid nations also have more efficient economies, higher wages and a smaller share of labourers who are long-term unemployed may not be entirely a matter of coincidence.

Given that the reform of labour laws is, contrary to popular perception, in the interests of the workers, what government needs to do is have this topic debated and explained so that workers, instead of opposing such reform, become its advocate.

The reform will need a substantial amount of intellectual input and will need complimentary policies for providing social security and welfare to workers.

But if this government can achieve a major rationalisation of India's labour laws, it will leave behind a legacy for many future generations.

To read Kaushik Basu's future columns, bookmark bbcnews.com/southasia

Here are a selection of readers' views:

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It can be good idea if the demand and supply of labour in the market matches. As in the present situation in India, there are too many unemployed labour that giving employer right to fire workers will result in them exploiting labour. Employees will be paid less and made to work long hours then specified in contract. Making employees work long hours without paying overtime wages has already become a norm in Software industry in india.
Varun Gupta, India

In absence of a secured social security system, it will be hard to implement hire and fire policy in India. Productivity in State undertaking are suffering more than the private sector due to absence of these kind of policy. Many state undertakings in Bihar state which employed people on political basis have come to the brink and can not be salvaged. If right people were recruited at the first place and inefficient fired, these undertaking might have some achievement to show- although this was not the only reason of its poor performance.
Prakash, USA

While most of Mr Basu's comments do sound correct, they seem to be more relevant to the more developed economies round the world rather than India's. What most economists miss out on is the fact that 10% of India's population (official unemployment in India) is a number much higher than 8% of the USA's population (official unemployment in the US). The social, economic and political ramifications of the sheer size of India's unemployed population may not make implementing liberal labor laws a happy story as Mr Basu suggests.
Ron Phoenix, USA

It seems that blind comparisons to the other economies and then presenting that as a remedy is too simple. For example Norway is much less rigid then India and their businesses are probably flourishing but Mr Basu fails to give any hints to the general social security available to a Norwegian. Does india have such a social net?
m.s. dhindsa, austria

I am surprised by Mr Basu's comments. I work in a multi national firm in Bangalore and they employ more than 100 people. This firm hires and fires staff giving them just one month's notice. The management now are removing staff who put in more than 4 or 5 years of service and taking in staff at the bottom of the scale just to save a couple of thousand rupees. Obviously our staff don't know whom to approach regarding this as there is no proper union either. Can somebody advise us on whom to contact in the Ministry of Labour or any other organisation?
Shankiah, India

The way India has shifted from socio-communistic to liberal-capitalistic policies in the last 20 years, there is no doubt that the labor reforms Dr Basu expects will be implemented in the near future. I think it will only help India progress further ans assure better standard of living.
Krishnakumar, USA

I'm truly astounded at the circular logic behind this need for labour law reform. Mr Basu's type of reforms may help certain companies, but an "efficient economy" doesn't necessarily translate into prosperity for those at the bottom of the corporate chain. Moreover, many of these countries have "a smaller share of labourers who are long-term unemployed" probably because one worker has to constantly switch jobs every few months and uproot their entire life every time just to make a buck. How does that help the worker in any way, living in fear of being laid off any time they get a job?
S. Basu, New Jersey, US

In theory labour flexibility is a good idea. However, it will require complementary skill training and re-training facilities. As Mr Basu will agree, the training & education infrastructure in India is in need of major overhaul. Labour reforms will definitely have to be preceded by a debate on training infrastructure and pedagogy.
Rit Chandra, India

The inertia against labour reform can be attributed to an uninformed (and often illiterate) public, short-sighted policymakers and vote-banking along economic lines. Although Prof Basu makes a compelling case for labour reform, the only way to enact this change is to educate the poorer workers enough so that they fully comprehend the idea of flexible labour.
Anupam Banerji, Australia

Basu might be speaking for India, but I am sure the picture he portrays is true for many South Asian economies including Sri Lanka. The labour laws in Sri Lanka are so favourable towards the workers that it has sometimes becomes the key reason for the closure of business enterprises. I am not sure whom to blame: the policy advisors for continuously maintaining the blind eye or the politicians for blindly protesting against any labour reforms.
Chanuka Wattegama, Sri Lanka

It is clear that there is a direct correlation between perceptions of job security and productivity in the manufacturing sector. The worker who knows that the quality of his work has little or no bearing on whether or not he will be dismissed has a tendency to become complacent and stymie the growth of the whole organization. Contrarily, employees who do not enjoy such high levels of job security tend to overachieve in order to prove their worth. What is also clear is that those with enough influence to overhaul the labour laws in India have attained a level of job security which allows them to be complacent enough to let things stay as is.
Moez Nomanbhoy, USA

It is highly unlikely that Indian labour laws will ever change where firms can hire and fire freely. Indian firms have the technology and the intellectual capital to compete with China in the global market scenario but this seems a classic case where our democracy is losing to the Non-democratic China. We do reforms when we are pushed against the wall just like the opening up of economy in 1991 . We need to be proactive and not always democratic to make laws which will yield results for our future generations.
S Bhattacharya, Pittsburgh USA

Prof Basu has the Midas touch of explaining economic reforms of different countries based on their labour system. For example, data compiled by World Bank gives us a clear picture of lower the score better the economic growth of the state. Throwing light upon the province of West Bengal, this kind of pernicious rigidity is the vote bank of the ruinous Communist Party. I would like to request Prof. Basu to release another article comparing the ceasing condition of West Bengal to the industrially flourishing states in India. These articles would help to open the eyes of the adamant and blind leaders of the so-called Marxist govt. and build a better future for West Bengal.
SRIJEET CHAUDHURI, Canada (formerly India, West Bengal)

It seems Kaushik Basu does not have any familiarity with how things are done in India. These days, in India, 88% of the manufacturing take place in the informal sector. Run on the basis of caste and kinship or village ties, this sector is hardly influenced by legal reforms. Multinational and big businesses outsource their operations to the informal sector, which flout all regulations, environmental or labour to keep the cost of production low. Basu must come down from his academic ivory tower to take note of the ground reality.
Sarasij Majumder, United States

Good advice. But it will prove fruitful only if we can get India's fattened, inefficient, overly political, bureaucratic, left-leaning policy makers to learn from it.
Ranjan Ranganathan, India

Unfortunately, ultra-liberals like Dr Basu are taking over Indian economic thought, which will eventually bring about the death of its labour movements which have protected its vast and poor workforce since the birth of the state. The ideals of these US-World bank neo-colonialists are to turn our workforce into neo-slaves, so that they can hire and fire at will. I would have expected the BBC to print counter opinions to challenge the hegemony of such an ideology.
Partho Sen Gupta, India

I look forward eagerly to Prof. Basu's advocacy of the repeal of laws against slavery, and accompanying explanation of how slavery is actually in the best interests of the slaves.
Nick, Scotland

The key point is that by protecting the rights of a very small minority of workers in the organised sector, a larger pool of workers in the unorganised sector is left behind without even the minimal protection of fare wages and a proper working environment. The tragedy of India is the Communist parties punching way above their right and fighting for the wrong ideas in this case.
C P Madhusudan, London

I am in agreement with comments made by Rit Chandra on the Basu article. I would like to add that as a student in America, I discovered that access to health care is inextricably linked to employment. While considering labour reform in India, I feel it is important to consider the link to health care reform and insurance sector reform. Silo thinking cannot help.
Srinivas Bodapati, India

It is rightly observed that we opened our economy when we were forced to in 1991. It is true that nothing is initiated by the Indian government unless it becomes imperative. If our labour laws are librated from political rhetoric, we can attempt to have a better infrastructure for economic growth. To add a job guarantee bill is not a step forward, but it will kill the golden goose which is the private sector.
Navodit Mehra, India

Though labour laws are tight, businesses have always found way to go around them. A large part of the Indian labour force remains in the un-organised sector. Though I see some advantages, I don't see this as silver bullet for solving India's economic woes. In reality, it is always a multi-pronged strategy that works. Also, all the economic advice/policy guidance in the world will not succeed if society is not ready to accept it.
Shailesh Gala, USA

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