Labor Distortions Could Derail India’s Economic Resurgence

June 3, 2020

India emerged as the world’s fifth largest economy by nominal GDP last year, leapfrogging France and the United Kingdom, according to the International Monetary Fund. PricewaterhouseCoopers’ “The World in 2050” report forecasts India’s GDP will rise to second worldwide within 30 years. However, the authors also state that emerging economies like India will have to strengthen their institutions and infrastructure to enable them to actualize a promising growth trajectory. India’s archaic labor laws are not considered industry friendly and have been holding back its economy from growing at its full potential. India’s labor laws reflect a mindset of the state exercising negative control over business enterprises. The poor pace of its notoriously rigid labor reforms has surely been a dampener on attracting more foreign direct investment (FDI) from the United States and other developed countries. Even domestic investments have suffered on this account. Covid-19-related labor disruptions could worsen the situation and limit the political space for the much-needed economic reforms.

Despite its GDP growth, India had witnessed its highest unemployment rate in the last 45 years, according to the latest Government of India’s Periodic Labour Force Survey (PLFS) and corroborated by the Centre for Monitoring Indian Economy’s 2019 data. Now, with the contraction in its economy due to Covid-19, India’s unemployment rate has soared. The country’s labor force participation rate has also fallen, according to the PLFS report. The absolute size of India’s labor force has been the subject of debate and stood somewhere between 470 to 520 million before the lockdown. During April and May 2020, India saw a large-scale contraction in its labor force, hopefully a transient phenomenon that will lessen with the easing of the lockdown. In any case, such an unprecedented economic downturn in one of the world’s largest economies, coupled with daunting challenges in the midst of a global pandemic, will lead to its own set of ripple effects. It is likely to have an impact on economic and trade relations with the rest of the world, as exemplified by a recent provision for India-made defense goods and import restrictions.

A Variegated and Informal Labor Market

India’s labor and employment data architecture is not fully reliable due to crucial information gaps. As a result, most policymakers rely on estimates extrapolated from somewhat questionable data. Despite these limitations, it is evident that almost 44 percent of India’s labor force works in agriculture, a sector that contributes a mere 15.4 percent to the country’s GDP. Similarly, 24 percent of the workforce is engaged in industry (including the manufacturing sector), which accounts for 23.1 percent of India’s GDP. The service sector employs 32 percent of the labor force yet accords as much as 61.5 percent to the country’s GDP. This sectoral differentiation also gets reflected in their earnings and well-being, or lack thereof. Since agriculture is the least remunerative segment with unstable growth, its workers have been endeavoring to enter other sectors but with limited success because of a lack of opportunities.

It is a bit simplistic to think that the complex web of India’s federal and state labor legislations have been useful in protecting the interests of workers, especially since such stringent laws have primarily been responsible for 93 percent of the country’s workforce remaining in the informal and unorganized sector, as per India’s Economic Survey of 2018-19. This engenders poor adherence to minimum wages and severely inadequate access to social security. Such a large-scale informalization of labor is unique to India. It temporarily helps industry but results in many in the workforce leading lives of almost unimaginable deprivation.

Indian industry has found workarounds to avoid problems emanating from its labor laws. Over the last few decades, companies have resorted to large-scale temporary hires, contract labor, daily wagers, jobbing work, outsourcing, and even artificially splitting business enterprises into smaller entities to avoid applicability of such laws. Some labor sector experts suggested that after the introduction of the Goods and Services Tax in 2017 and the demonetization of high-denomination currency in 2016, the situation would improve since businesses would have new incentives to become part of the formal economy. On the contrary, however, the informalization of labor in India seems to have increased as there has been little respite from the clutches of outdated labor laws.

Investor-Friendly Labor Reforms

The Industrial Disputes Act of 1947 has been a big roadblock for the closure of industrial units and the layoff of workers if a business employs more than 100 workers. Given the uncertainties with most businesses, only some aggressive investors from the United States or other developed countries have been willing to tolerate a situation that, in the event of the enterprise collapsing, would require the investor to remain straddled with workers for whom exit options are either closed or cumbersome. Labor laws remain an important factor for risk-averse investors considering India as a production hub. Recent months have seen some movement on this front that may eventually mean that only those firms employing more than 300 workers would require the government’s concurrence prior to retrenching their workers in the future.

There are many such pain points related to labor laws. The Contract Labor Act and the Industrial Employment Act have several elements of rigidity. The Small Factories (Regulation of Employment and Conditions of Services) Bill planned a few years ago, under which factories with a labor force of 40 workers or less were to be brought under a simpler regulatory regime with a waiver on the applicability of 14 federal labor laws, has been a non-starter. This idea should be revived with an increased labor threshold and tracked to closure.

NITI Aayog, the government’s think tank, has been advocating extensive labor reforms—both at the federal and state level. However, a sweeping withdrawal of most labor laws by states almost overnight during the recent lockdown and for a limited duration appears far too drastic. Well-thought-out and liberal labor laws would go a long way in ensuring workers’ welfare as well as in soliciting FDI into India.

Labor is a subject on the Indian Constitution’s concurrent list, so both the federal and state governments must work in tandem on reforms. The federal government should make good on its commitment to rationalize and simplify the 44 central laws into four codes: salary and wages, social security, industrial relations, and health and occupational safety. The Industrial Relations Code was introduced in the Indian Parliament in November 2019 but is now lying with the Standing Committee. Work on all these four codes has progressed but should be speedily taken to its logical end as the post-Covid-19 economy creates jobs in tandem with expected economic growth.

Many labor laws are under the state domain. Based on the recent work on labor reforms undertaken by the Government of India, there is a lack of clarity if federal laws would become more paramount and if state powers on labor issues would diminish. Whether states would retain the jurisdiction to tweak the laws based on their local requirements remains ambiguous. If the role of states in labor laws remains unchanged, then the Government of India should draft a unified model labor law for states, replacing many archaic laws for time-bound adoption by the state governments.

Once these are enacted, several investors who dread the unfriendly Indian labor laws would be incentivized to invest, which should create large-scale employment, especially in labor-intensive industries. In addition, India could attract a significant component of investments and create jobs emanating from growing anti-China sentiment worldwide. The velocity of action on this front would make or mar India’s case to become the next workshop of the world.

Recent State-Level Rollback of Labor Laws

Ostensibly as a response to the Covid-19-triggered societal lockdown, the Indian states of Uttar Pradesh, Madhya Pradesh, Gujarat, Rajasthan, Maharashtra, Odisha, Punjab, and Goa have amended some of their labor laws by changing provisions or suspending some. These include states ruled by the Bhartiya Janata Party (BJP) as well as the Indian National Congress, the national opposition. In Uttar Pradesh, Rajasthan, Gujarat, and Himachal Pradesh, industrial units were allowed to deploy workers for 72 hours a week, a 24-hour increase from the earlier norm of 48 hours. Experts argue this is not in keeping with the International Labor Organization’s convention. In a few states, there is a lack of clarity as to whether industry necessarily has to pay overtime for the incremental work.

India’s most populous state, Uttar Pradesh, has suspended most labor regulations for three years, subject to presidential assent. While Indian industry has generally welcomed these changes, they have not been received well by most labor unions, including the Bharatiya Mazdoor Sangh, which is supported by the BJP’s primary ideologue, the Rashtriya Swayamsevak Sangh (RSS). Observers and experts have argued that such retrograde measures are unconstitutional and may possibly even take India back to the slavery and barbarism of medieval times. The complete removal of labor regulations could trigger a backlash against even modest, helpful changes in the future.

Further, while these sweeping rollbacks of labor laws by some Indian states may be framed as business friendly, they also signal a general environment of policy instability and recklessness, which may dampen investor sentiment. Investors tend to respond positively to comprehensive and well-thought-out legislative changes and unfavorably to unpredictability. Sustainable long-term foreign investors are unlikely to imperil their business strategy, perceiving flip-flops in labor regulation as an untenable risk and an impediment to continuity, especially given India’s onerous laws that make it difficult for firms to exit in the event of failure.

Key to fostering industry’s trust is to solicit and give value to their inputs even when governments need to respond to unique and dynamic circumstances. Businesses would much rather operate in a predictable and sensibly liberalized regulatory environment than be shortsighted enough to assume that the Wild West of suspended labor laws would remain indefinitely. This is especially the case since even a preliminary analysis of the political economy of Indian labor unions, given their often symbiotic linkages with their parent political outfits, would suggest they have enough influence to effectively advocate for a restoration of the revoked legislation. Moreover, both organized and unorganized labor may emerge as more reactionary and combative in the future if labor laws are harshly withdrawn, harming the long-term interests of industry in achieving policy and legislative change in the event the government is strong-armed into restoring en masse the very labor laws that were revoked.

Vulnerability of Migrant Workers

The lockdown has made clear one of the dangerous manifestations of the informalization of labor in India—the challenges migrant labor face. Migrant workers are often ignored by planners and policymakers. Large-scale reverse migration triggered by the Covid-19 slowdown has accentuated their difficulties in receiving public services. Migrant labor is seen in large numbers in industrial clusters, construction sites, and infrastructure projects. They keep the wheels of industry running, build highways, and create infrastructure. However, migrant labor remains marginalized in India’s political economy despite their cardinal role in nation-building.

Having experienced challenges, and with meager prospects in the urban economy, a significant proportion of migrant laborers have returned to their ancestral homes, often hundreds or even thousands of miles away. It appears that some of them are unlikely to return to metropolitan areas, industrial clusters, or infrastructure sites soon. Indian industry, of all sizes, would therefore have to reconcile with a delay in the resumption of full-scale industrial operations.

A Case for Fairness and Equity

Labor regulation should balance the interests of both industry and workers in an equitable manner. Basic social security measures to take care of sickness, accidents, old age, and unemployment need to be extended to India’s informal workforce as well. India should seriously explore instituting unemployment insurance and the statutory minimum wage at the national level to cover all categories of workers. Reform is also required to ensure safe working conditions for Indian workers. Livelihood opportunities in India’s gig economy have grown the fastest in last few years. While most gig economy workers may not strictly be classified as employees in the legal sense, laws should provide for at least a basic social security measures to be funded by the companies.

India’s low-skilled labor force is physically on the move while governments at every level are dramatically altering labor regulations. These two simultaneous shifts could dramatically impact India’s overall reform program and economic prospects. While there is no denying that industry-friendly labor laws are an absolute necessity in India, the post-reform labor laws should not just be seen as paving way to an easier “hire-and-fire” policy. Fostering trust through transparent and frank multi-stakeholder dialogue is critical. It is a tough balancing act between wantonly implementing the minimalist and simpler laws advocated by overseas investors and ensuring an appropriate safety net for workers. The government should convince workers that their constituency is being addressed first through these reforms, which would benefit them as India eventually gets into a high-growth trajectory, creating many more jobs in the employment-starved economy.

Jayant Krishna is a senior fellow (non-resident) at the Center for Strategic and International Studies in Washington, D.C., and executive director, public policy at the Wadhwani Foundation, a U.S. nonprofit, based in New Delhi.

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