LABOUR MARKET IN STATES

Achin Chakraborty, EPW , 2015

INTRODUCTION

1. The “need” for reforming the labour market in India has been forcefully articulated by
protagonists of economic reform ever since major reform measures were
implemented in several sectors of the economy in the 1990s.
2. According to Chakraborty, Industry and business interests, the corporate media, and
a section of economists have been repeatedly complaining about the so-called rigidity
in the labour market in India allegedly because of a bunch of protective legislations
that has made the retrenchment of workers difficult, and has been clamouring for
labour market reform.
3. In the Constitution, labour belongs to the concurrent list, which means that both the
centre and the states can legislate in the area and the central law will prevail in case
of any contradiction. As there are major central laws on labour, individual states can
amend them. Once a state legislature passes a bill, the union government forwards it
to the president for assent. If the president assents, it becomes a law in the state.
4. A number of states have made amendments in the provisions of the Industrial
Disputes Act (IDA), 1947 and other acts relevant to labour. But, by and large, those
amendments have had very little impact on the general perception of industry and
business that labour laws in India are rather stringent.
5. Indian labour laws, as alleged by both domestic and foreign investors, provide a high
degree of protection to labour since
a. Retrenchment of workers and closure of an unviable unit requires prior
permission of the state government for companies employing more than 100
workers.
b. This leads to the complaint that firms lack the flexibility to adjust to changed
economic circumstances in the post-reform era.
6. By the central government’s amendment to the IDA passed in 1982 (made effective in
1984), only companies employing up to 100 workers were allowed to do so. The
motivation of this article is the recent initiatives in reforming the major laws to do with
labour.
a. Late last year, (2014) we saw Rajasthan amend the IDA, the Contract Labour Act,
1970, and the Factories Act, 1947, which finally received the president’s assent
in November.
b. The most important was the changes in the IDA that will now allow companies in
Rajasthan employing up to 300 workers to lay them off or close down the unit
without seeking government approval.

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 c. Secondly, the threshold of the number of employees required for applying the
Factories Act has been increased from 10 to 20 in electricity-powered factories
and from 20 to 40 in factories without power.
d. A third major amendment says that a union now has to record a membership of
30% of the total workforce to be recognised, up from 15% earlier.
7. Initiatives of this kind ostensibly aim at improving what is called the “ease of doing
business.” Rajasthan Chief Minister Vasundhara Raje chose to clarify the
government’s motivation with the explanation that the reforms would create “a fertile
habitat for jobs creation.”
8. Chakraborty anticipates that other states, in particular where the BJP is in power, will
follow Rajasthan’s footsteps. Madhya Pradesh (MP) has already passed a similar bill,
and Haryana and Himachal Pradesh (HP) are reportedly contemplating similar
amendments.
9. Critiques of labour market reform that aim at increasing labour market flexibility
a. Usually argue from a normative rights-based position which gives priority to job
security as the most important aspect of workers’ rights.
b. In this article Chakraborty takes a different route he elaborates on what he calls
the “futility argument” to establish that it would be wrong to claim that such
reforms would achieve what the advocates of reform expect them to achieve,
given the realities of the Indian labour market. In other words, he seeks to show
that the aforementioned reforms would not succeed in raising the rate of
economic growth and generating employment at a faster rate.

HOW RIGID IS THE LABOUR MARKET ?

1. According to Chakraborty the Indian growth story has so far been one of jobless
growth.
a. Despite a marked acceleration in growth of GDP in the post-liberalisation period,
employment growth has been falling in the last 3 decades.
2. Using various rounds of National Sample Survey Office (NSSO) data, it has been
estimated that
a. average annual employment growth was about 2.4% in the 1970s. This continued
in the 1980s, but declined in the 1990s.
b. Between 1999–2000 and 2004–05, there was a spectacular jump in employment
growth to 2.8%, which he finds is hard to explain.
c. However, the compound annual growth rate (CAGR) of employment from 2004–
05 to 2011–12 fell to a mere 0.5% from the earlier 2.8%.
d. According to Chakraborty from 2004–05 to 2009–10, in which GDP grew at
unprecedented rates, employment collapsed to virtually zero.
3. There have been gradual changes in the structure of employment as well.

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 a. The share of the primary sector in total employment has, for the first time, fallen
below 50%. It declined from 58.5% in 2004–05 to 48.9% in 2011–12.
b. The share of the secondary sector increased from 18.1% in 2004-05 to 24.3% in
2011-12
c. And that of tertiary sectors increased from 23.4% to 26.8%, between 2004-05
and 2011–12.
4. Self-employment continues to dominate, with a 52.2% share in total employment.
5. India’s total labour force in 2011–12 is estimated to have been about 484 million,
following the definition of “usual status” (principal plus subsidiary). This is about 40%
of the total population.
6. The overall low labour force participation rate reflects the disproportionately low
labour force participation rate among women. In rural areas, the female work
participation rate has remained stagnant. Such trends clearly point to the need for
diversification in rural livelihoods from agriculture to non-agriculture activities.
7. The most remarkable feature of the 480 million-odd workforce is that more than 90%
of them belong to the category of informal workers.
8. It is worth noting that the National Commission for Enterprises in the Unorganized
Sector (NCEUS) made a very important distinction between the unorganised sector
and informal workers.
a. The NCEUS followed the standard definition of the unorganised sector
comprising all unincorporated private enterprises owned by individuals or
households engaged in the sale and production of goods and services operated
on a proprietary or partnership basis and with less than 10 workers (with
electricity; less than 20 without electricity).
b. It defined informal workers as “those working in the informal sector or
households, excluding regular workers with social security benefits provided by
the employers, and the workers in the formal sector without any employment
and social security benefits provided by the employers.”
9. Table 1 has been taken from the Economic Survey (2014–15). It shows that
a. The share of the organised sector in the total workforce increased from 13% to
17.3% between 2004–05 and 2011–12, which looks like a significant
improvement. But it may be remembered that not all workers engaged in the
organised sector can be considered formal workers.
b. Among those employed in the organised sector, a high 48% belonged to the
category of informal workers in 2004–05. And this share increased to 54.6% in
2011–12 (Table 1).
10. The trends in formal and informal employment inevitably raise the question of how
rigid India’s labour market is.

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 a. The evidence available shows that even though no significant changes have been
made in the labour laws in the last 25 years, regimes of employment, instead of
remaining ‘
b. static, have adapted in covert ways to accommodating more and more workers
without any modicum of security.
c. This has been made possible by even employers in the organised sector
increasing their reliance on casual and contract workers. We thus have the
peculiar paradox of a so-called rigid labour market that has within it the mass of
workers who can be hired and fired at will.
11. The mobility of people seeking work from rural to semi-urban and urban areas has
increased over time. Very few of them end up securing a regular job in the organised
sector.
a. Yet, NSSO data typically show very low rates of open unemployment in India.
b. Since the large majority of the people who desperately move out of agriculture
end up in a variety of informal and seasonal employment, it is reasonable to
believe that there are varying levels of underemployment between those who
are fully employed and those who are not.
12. Can labour market reforms reverse the process of growing underemployment and
informalisation?
13. According to Chakraborty it is unlikely.
a. The crucial stumbling blocks are usually said to be
i. the relatively small share of manufacturing in the economy and
ii. the low employment intensity of services.
b. Services contribute close to 60% of GDP but employ only 27% of the workforce.
While the contribution of manufacturing to GDP is 16%, it employs only 13% of
the workforce.
c. Since wage earnings of informal workers are typically much lower than those of
formal workers, increasing informalisation means a decreasing share of labour in
total value added, and an increasing share of capital.
14. From the macroeconomic point of view, this can effectively create a demand problem
in the economy, which, in turn, could affect growth prospects in output and
employment.
a. Chakraborty feels that unless incomes at the lowest end of the employment
spectrum are protected, [i.e. minimum wages disconnected with productivity
and demand and supply relationship] demand for mass consumption goods may
not rise.
b. Therefore, according to him the kind of trend—the shift of the labour force from
agriculture to non-agriculture—that we observe in the Indian economy can
hardly be seen as a positive development dynamic since most of them end up in

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 the unorganised or informal sectors where earnings are low, work conditions are
generally dismal, and the fear of termination is always there.
15. Finally, Chakraborty feels that while one can argue that a desirable solution would be
to create more formal employment in the organised sector, but the terms of contract
should not be such that they create disincentives for employers to expand
employment. But this is easier said than done. While at the policy level it is assumed
almost as a truism that more relaxed labour laws will expand employment, neither
economic logic nor the evidence is able to support this.

THE LOGIC OF FLEXIBILITY

1. Two papers based on the empirical information on changes in laws on labour in India,
which have had the most influence in policymaking circles, are Fallon and Lucas (1993)
and Besley and Burgess (2004), particularly the latter.
2. Before we present a brief review of this literature based on the evidence, we take a
quick look at the theoretical arguments for labour market flexibility.
3. It was common in the theoretical literature of the 1980s and 1990s to explain unemployment in
developed countries in terms of a simple model of a non-clearing labour market, where employment
and real wage were given by the intersection of a downward-sloping demand curve for labour and an
upward-sloping wage-setting curve, with a labour supply curve to the right of this interaction. In this
model, while the labour supply and labour demand curves have usual interpretations, the wage-setting
curve was novel. But it has no unique interpretation, and has been interpreted differently in different
models. For example, in the efficiency wage theory of Shapiro and Stiglitz (1984), it can be interpreted
as a no-quitting or no-shirking locus, or in the insider–outsider (I–O) theory of Lindbeck and Snower
(1990), it may represent an insider’s wage claims.

4. In this kind of theoretical set-up, the persistence of unemployment may be shown by

making the positions of the labour supply, labour demand, and wage-setting curves
depend on past levels of labour market activity. In the insider-outsider [I–O] model,
labour turnover costs play an important role in a firm’s employment decisions and in
enabling insiders to gain market power in the wage setting process. Job security
regulations also play an important role in this model, which provides the justification
for a policy of lower regulation to enhance labour market flexibility.
5. However, according to Chakraborty, if the prevailing wage rate is found to be above
the so-called market-clearing rate, I–O is not the [only] obvious explanation.
6. Even if there are no job security regulations, firms may find it unprofitable to cut
wages given involuntary unemployment. Different variants of the efficiency wage
hypothesis argue that labour productivity depends on the real wage paid by a firm.
Therefore, even if the labour market is competitive, firms may choose to pay wages at
a rate above the market-clearing one for several expected benefits—
a. less shirking by employees because of the higher cost of job loss,
b. lower turnover,
c. improved morale, and so on.

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 7. Thus, we are in a curious situation. The same empirical observation of involuntary
unemployment together with a wage settled above the reservation wage of the
unemployed is consistent with two alternative theories, one of which has labour
market flexibility as a policy implication while the other has no such implication.

Other Models

8. The I–O model of wage setting is therefore not the only explanation for the
persistence of involuntary unemployment in the theoretical literature, even though
policy advocacy for labour market flexibility is the logical outcome of the model. There
are other explanations that have little to do with rigid institutional rules that make
labour retrenchment difficult. Shapiro and Stiglitz (1984), for example, show how the
information structure of employer–employee relationships, in particular, the inability
of employers to observe workers’ on-the-job effort in a costless way, explains
involuntary unemployment as an equilibrium phenomenon. In their model,
unemployment results from imperfect monitoring of effort. In equilibrium, all firms
pay the same wage above the market-clearing rate, and unemployment, which makes
job loss costly, serves as a device for worker discipline.
9. Having gone through these theoretical insights, Chakraborty says that one might argue
that the models to explain the persistence of unemployment in Europe and the United
States (US) and their implications for a policy to ensure labour market flexibility have
little relevance in the Indian context. At the other extreme, papers have been written
to argue for the “benefits from rigid labour markets” in the Western context (Agell
1999).
10. Having gone through the theoretical models of involuntary unemployment,
particularly those based on a strong positive relationship between wage and
productivity, such as the efficiency wage models, one would think that they are
irrelevant because wage–productivity relations are rather blurred in the Indian
context for rigidities in the labour market.
11. Chakraborty feels that this would be a mistake. It seems that the wage–productivity
nexus is important in some sectors of the economy, but not in others.
a. For the primary sector, where the efficiency wage hypothesis is relevant, job
rationing and voluntary payment of wages in excess of market clearing may be
found.
b. In the secondary sector, where the wage–productivity relationship is weak
[because of TUs?] or non-existent, we should observe fully neoclassical
behaviour.
c. The existence of the secondary sector does not, however, eliminate involuntary
unemployment because the wage differential between primary and secondary
sector jobs will induce unemployment among jobseekers who choose to wait for
primary sector job opportunities.

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EMPERICAL STUDIES IN THE INDIAN CONTEXT

12. Turning to empirical studies in the Indian context, we observe that the focus of most
of them is the IDA, 1947, in particular Chapter V-B where the minimum number of
workers to qualify for exemption from government’s approval to effect any lay-off or
closure has been specified.
a. This chapter was inserted by an amendment to the act in 1976, which stipulated
that firms employing 300 or more workers would require the government’s
permission to retrench or lay off workers, or to close down a unit. This was
ostensibly to protect workers from arbitrary dismissal and to avoid the political
repercussions of large-scale job loss due to closure of firms.
b. However, according to Chakraborty, it was subsequently found that more
effective protection of workers’ interests would need a further reduction in the
minimum size of the unit for exemption. In 1982, a further amendment was made
to reduce the minimum number of workers from 300 to 100.
13. Fallon and Lucas (1993) used these episodes of change in the IDA to examine the effect
of the legislations on employment. Besley and Burgess (2004) used information on
various legislations by states to amend the IDA.
a. Bhalotra (1998) raised a number of questions on the method in Fallon and Lucas
(1993). Her own finding suggests that the apparent increase in labour market
flexibility in the 1980s, despite the tightening of the job security legislation, could
be attributed to a growing trend towards subcontracting output to small firms,
which were outside the scope of the law, and to firing workers, which occurred
despite the provisions of the law.
b. Bhattacharjea (2007) made a thorough critique of the methodological strategy
adopted in these empirical studies and persuasively showed how weak the
ground was to claim that “pro-worker” states lagged behind “pro-employer”
states in terms of generation of employment.

WHAT FLEXIBILITY CANNOT ACHIEVE

1. Chakraborty questions how making amendments to the IDA and other acts, as
Rajasthan has done, will push manufacturing forward with increasing output and
employment.
2. Bardhan (2014) cites the example of the garments industry, which is known to be very
labour intensive.
a. By combining the Annual Survey of Industries (ASI) and NSSO data, he estimates
that about 92% of garment firms in India employ eight or fewer workers.
b. Surely the firms could have expanded if they had wanted to, at least the labour
laws would not impose any constraint until they become 100-worker firms.

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 c. But that 92% of them have not grown beyond their present size implies other
factors are at play, which are far more important than the labour laws that are
assumed to be rigid.
3. The problems may have to do with issues other than labour laws such as inadequate
credit and marketing opportunities, bad infrastructure, erratic power supply,
bureaucratic hassles, and so on.
4. At the other end, amending labour laws is unlikely to have a major influence on the
further growth of industries such as the pharmaceutical sector [skill and technology
intensive], which has been considered one of the most successful in India, mainly
through a favourable patent regime that facilitated reverse engineering and
innovation.
5. One might ask, what are the constraints that inhibit Indian manufacturing from
following the path that the pharmaceutical industry has taken?
a. Reverse engineering does not yield an immediate improvement in productivity.
Therefore, firms with the objective of maximising profits in the short term are
unlikely to carry it out.
b. More importantly, Indian business generally chooses to compete on price with a
high degree of reliance on reduced wage costs by using contract labour. With
contract labour, there is a high degree of attrition, which means that it does not
make much sense to develop skills through in-house training.
6. Nathan et al (2014) find evidence that firms that compete on quality and product
innovation have a stable workforce, whereas those that compete on price utilise a
flexible workforce.
7. Continuous improvement in productivity is needed to remain competitive, and this
requires a stable workforce that has a stake in fostering improvements in productivity.
For productivity growth to translate into higher wages, incomes, and improved living
conditions, it is necessary to build strong and well-functioning labour market
institutions (Amjad et al 2015).
8. Finally, mitigating the growing problem of “graduate” unemployment requires an
approach different to amending the IDA.
a. The rate of unemployment among graduates, including those who were
technically trained in 2011–12, was 18%. If this information is combined with the
largely anecdotal evidence of a labour shortage in industry and the steady
increase in nominal wages in the organised sector, the disconnect between
growing enrolment in higher education and forming appropriate kinds of skills
becomes apparent.
9. Chakraborty feels what is perhaps needed is education reform rather than the kind of
labour reform that Rajasthan has enacted [Both are needed? - Labour reforms are
targeted at unskilled worker].
a. The National Skills Development Corporation is not a panacea, but it is a move in
the right direction. The corporation needs to work closely with industry.

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 b. A bargaining process between trade unions and enterprises needs to produce the
terms of separation that unions agree to in accepting loss of job security. Social
security for workers needs to be strengthened rather than weakened in the name
of labour market flexibility.
10. There cannot be a blanket argument against contract labour (firms should be allowed
the flexibility to take on short-term employees) but the wide gap between
employment conditions for contract and regular workers has led to increasing
incidents of industrial strife that has vitiated the environment for manufacturing.
a. The large-scale violence at the Manesar plant of Maruti Suzuki and Honda
Motorcycle and Scooter India a few years ago, and similar incidents reported
elsewhere show that labour institutions in India are ineffective in resolving
conflicts and facilitating collective bargaining.
b. The growing sense of injustice and discontentment among the industrial labour
force in recent times needs to be faced with sensitivity and caution while thinking
about labour market reforms.
11. While industry and business hail Rajasthan’s initiative in amending the laws, the fact
is that the state has the highest number of child labourers after Uttar Pradesh and
Andhra Pradesh, according to the United Nations Children’s Fund’s (UNICEF) Child in
India 2012 report.
12. Admittedly, labour market reforms are not all about increasing the freedom to hire
and fire. They are also about the social security provisions and conditions of work on
the side of workers, and avoiding unnecessary bureaucratic hassles on the side of
firms.
13. The Economic Survey (2014–15) lists the reform measures that the central
government has undertaken, which seem to be about either improving workers’
benefits or saving industry from the unnecessary hassles of an inspector raj.
a. Raising the statutory wage ceiling under the Employees Provident Fund and
Miscellaneous Provisions (EPF&MP) Act to Rs 15,000 per month from 1
September 2014, introducing a minimum pension of Rs 1,000 under the
Employees’ Pension Scheme 1995, amending the Apprenticeship Act, 1961, and
so on are ostensibly to benefit workers.
b. A unified labour portal called Shram Suvidha Portal has been launched for the
“timely redressal of grievances and for creating a conducive environment for
industrial development.”
c. The filing of a single self-certified and simplified online return under this scheme
instead of the earlier practice of filing 16 separate returns, and transparent
labour inspection processes are expected to reduce the hassles for the industry
(see Government of India 2015: 137, Box 9.3).
14. But, according to Chakraborty, all these are too little to attract attention as far as the
contested terrain of labour market reforms is concerned.

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 a. However [he feels], highlighting these measures in the Economic Survey while
underplaying the push towards more flexibility in hiring and firing seems aimed
at giving the impression of a kind of “labour reform with a human face,” perhaps
to facilitate far wider and deeper reforms. Such subtleties were not visible a few
years ago.
b. The Economic Survey for 2005–06) [for example] said,
i. various studies indicate that Indian labour laws are highly protective of
labour, and labour markets are relatively inflexible.
ii. These laws apply only to the organised sector. Consequently, these
laws have restricted labour mobility, have led to capital-intensive
methods in the organised sector and adversely affected the sector’s
long-run demand for labour.
iii. Labour being a subject in the concurrent list. State -level labour
regulations are also an important determinant of industrial
performance. Evidence suggests that states, which have enacted more
pro-worker regulations, have lost out on industrial production in
general.
15. According to Chakraborty,
a. These [above] lines were clearly a reflection of uncritically accepting the findings
of papers such as Besley and Burgess (2004), which claimed to have established
a connection between state-level labour regulations and industrial performance.
Over time, the influence of these studies has waned because other findings have
questioned the connection.
b. As states compete with each other to attract investment, they find labour market
reform a convenient way of signalling their investor friendliness. Given the ruling
coalition’s weak position in the upper house of Parliament, any major reform
initiative is unlikely to go unchallenged.
c. The states, on the other hand, may garner political support for certain reforms
within their territories by invoking the imperatives of interstate competition.
d. As a consequence, the central government can conveniently absolve itself of the
responsibility of amending labour-related laws.

CONCLUDING REMARKS

1. In his monograph The Labor Market as a Social Institution, Solow perceptively

observes,

Wage rates and jobs are not exactly like other prices and
quantities. They are much more deeply involved in the way
people see themselves, think about their social status, and
evaluate whether they are getting a fair share out of the

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 society ... Social institutions define acceptable and
unacceptable modes of behavior in the weighty context like
the labor market (1990).

2. Yet, the arguments for flexibility in the labour market are usually couched in the
language of market clearing through a downward movement of the wage rate.
a. Hence, the wage rate is considered essentially no different from any other price
as far as its market-clearing role is concerned. So-called competitive pressures
tend to draw economies around the world into “a race to the bottom.”
b. Policymakers have been racing to make their markets more competitive and
increase incentives to invest. Labour markets are being subject to changes
intended to enhance flexibility and lower labour costs.
c. Social security measures are perceived as inimical to competitive advantage and
growth. That the inevitable result of all this has been widening gaps in income
and well-being is now accepted by many with greater equanimity than before.
3. However, hardly any commentator in the business media seems to appreciate the idea
that there is no inherent trade-off between dynamic efficiency and basic income
security for the working poor despite a long stream of theoretical literature on this
supported by strong empirical evidence (Chakraborty 2006).
4. It needs to be emphasised that job security is not the only means by which income
security can be achieved. But in the absence of any protective security, that would at
least partially compensate for income loss due to job loss, and workers have no other
option but cling to the demand for job security.
5. Chakraborty feels that unfortunately, even with all the power that workers can still
wield, they will hardly succeed in their struggle to resist losing jobs, whether the
market is reformed by legislative means.

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