LABOUR LAW REFORMS – BHAGWATI AND PANGARIYA NOTES.

 How does development take place?

1. Movement of workers out of agriculture into industry and services (around 50% are
employed in agriculture)
2. Progressive shift of workers from informal to formal sector (90% informal)
3. Rapid urbanization (66% in rural)
India’s progress on all 3 fronts has been very slow. According to the authors the main reason
for this is the stringent labor laws. Let’s understand the main reasons for the slow progress
1. Slow growth of manufacturing – A common feature of fast-growing low-income
countries is the rapid expansion of manufacturing (China, Vietnam, East-Asian
economies) pulling unskilled workers from agriculture into industry. India has failed
to do this. There has been a direct jump from agriculture to services sector. The share
of manufacturing industry in GDP actually fell from 16.8% in 1981 to 15.8% in 2009.
2. Poor performance of labor-intensive manufacturing – In a recent study, 31 out of
96 manufacturing were identified as labor-intensive industries. They accounted for
only around 13% of GVA in manufacturing. The fastest growing industries have been
automobiles, telecommunications, pharmaceuticals, finance and software. All of these
industries are capital-intensive. Capital intensive industries accounted for 40% of
commodity exports in 1991. The share of these products rose to 65% by 2008. For
readymade garments (which are the most labor-intensive goods) the share declined
from 12% to 6% during the same period.
3. Capital deepening – Labour-capital ratios in the vast majority of manufacturing
industries in India are lower than in other countries with similar development levels.
India’s productivity growth is driven by capital deepening. Capital deepening =
Increase in capital-labor ratio.
4. Firm size distribution – Employment in India is heavily concentrated in the small
enterprises. While the large enterprises have some presence, the medium size
enterprises are entirely missing. Let’s take a look at the data. Around 50% of the
workforce is self-employed and vast majority of these are working alone or with a
family member at most. According to the new definition, 99% of all firms are
MSMEs. Among these 99% are micro firms. Most of these hire 2 workers at most.
Large firms are concentrated in the capital-intensive sectors. 92.4% of workers in the
apparel sector are concentrated in small firms with 49 workers or less. This
distribution is in sharp contrast with China, where medium and large-scale firms
account for a gigantic 87.7% of apparel employment. In the capital-intensive sectors
within India, large scale firms employed 50.3% of workers in 2005.
The true explanation that most firms in India remain small lies in the fact that additional
layers of regulations and barriers remain to discourage the emergence of large-scale labour-
intensive manufacturing in India. The dominant cause is highly inflexible labor markets
which makes the cost of labor in the formal sector excessively high. Our stringent and rigid
labor laws apply only to large firms. This incentivizes firms to stay small in order to avoid the
labor laws.

 Understanding the labor laws

1. Labor is on the concurrent list on the constitution. That means that both the state and
the center can make laws on this subject. There are 52 central labor laws and 150 state
level laws. This brings the total to around 200 labor laws.
2. Some labor laws are in contradiction with each other. You can’t implement Indian
labor laws 100% without violating 20% of them.
3. Trade unions act 1926 – The act requires that firms with seven or more workers
should allow them to form a trade union. This gives firms with 6 or lesser workers the
most labor market labor flexibility. This incentivizes firms to stay small.
4. Factories act 1948 – This act applies to manufacturing units with 10 workers using
power and with 20 workers even if not using power. This limits the maximum hours
of work per week to 48, requires a paid holiday for each 20 days of work, limits work
without a day of rest to 10 days.
5. Other legislation – Minimum wages act 1948, Payment of bonus act 1965, payment of
gratuity act 1972 etc.
6. Industrial dispute acts 1947 – This covers all industrial disputes regardless of firm
size. It states conditions under which employers can alter the tasks assigned to
workers, conditions under which they can be laid off, and the rules regulating strikes.
It stacks the deck against the employers. The legislation defines an industrial dispute
as any dismissal, discharge, or retrenchment of a worker in a firm of any size. Section
9A of IDA requires to give workers a 3 week notice for change in working conditions.
Chapter 5-B makes it impossible to lay off workers in establishments with 100+
workers.
7. Contract labor act 1970 – Contract workers are hired indirectly and paid by a
contractor who has in turn contracted with the establishment. The establishment has
no direct direct responsibility to contract workers. Factories and establishments prefer
contract workers to avoid the burden imposed on them by the onerous labor laws.

 Sceptics of adverse impact of labor laws

1. According to the authors, stringent labor laws are the reason that firms in India stay
tiny. Labor costs rise due to labor legislation. Labor costs in apparel (highly labor
intensive) is around 80% of total cost while in capital intensive sectors, labor cost is
only 10% of total cost. Skeptics however say that firms in India are tiny due to
reasons other than the stringent labor laws. Let’s understand the argument of the
skeptics.
2. Lack of literacy – Skeptics blame a lack of adequate literacy among potential workers.
According to them, even the so-called unskilled tasks require a level of literacy that is
 lacking in India. This claim can be easily debunked. Gross enrolment ratio (GER) in
class 12 is very high (33%). GER in class 10 was even higher at 58%.
3. Lack of access to credit – Some argue that lack of credit is the reason most small
firms can not grow. But this argument too can be easily falsified by the fact that both
medium and large size firms account for a much larger employment in the capital-
intensive sectors than in labor intensive sectors. Unless something else, such as labor
laws have made apparel (labor-intensive) a riskier business than motor vehicles
(capital intensive) there is no obvious reason why the banks would discriminate in
favor of the latter in a labor abundant country.
4. Selection problem in surveys – It is argued that when interviewed for business
environment surveys, firms rarely point to labor market rigidities as the key problem.
Mid-size and large firms in the labor-intensive sectors which are likely to complain
about the onerous labor laws simply do not exist and are therefore not represented in
the survey. Large firms in the sample surveys also come overwhelmingly from the
service sector and these firms are not subject to some of the most constraining labor
laws such as chapter 5 B of IDA 1947.
5. Easy to get around labor laws – Some argue that while labor laws are stringent, they
are easy to get around. The fact that large firms have chosen not to enter labor-
intensive sectors in India while they routinely do so in other comparable countries
suggests that they’re not able to get around the labor laws in a cost-effective manner.
Being able to get around doesn’t mean getting around at low cost.
6. Large informal sector - The final argument is that labor laws in India apply only to a
tiny section of the labor force. 90% of the labor is in the informal sector and this
implies that the bulk of the labor market is highly flexible despite ill-designed labor
laws. However, this argument is a rather disingenuous one. After all, the entire debate
is about the smallness of Indian firms and absence of medium and large sized firms in
labor-intensive sectors.
 Interstate labor law differences
Hasan and Jandoc study state level differences in labor laws and outcomes. Flexible
labor markets are correlated with existence of large and medium sized firms. To be
sure that other factors are not behind the state-level differences, the authors do a
comparison between states with and without good infrastructure. This comparison
yields no real differences in employment shares.

 Labor laws: what must be done?

1. Reform of IDA 1947 – This legislation is stacked against the employers and prevent
expansion of firms. Several changes in the IDA are needed. Firstly, a tighter definition
of retrenchment to reduce disputes. Second, the IDA allows every single industrial
dispute to go to labor courts and tribunals. This practice must be replaced. Third,
section 9A of the IDA which imposes a heavy burden on an employer wishing to
reassign a worker to an alternative task needs to be replaced by one that gives the
employer greater flexibility. Fourth, chapter 5-B of the IDA 1947 which makes it
nearly impossible for an employer of a factory with more than 100 workers to lay off
workers under any circumstances needs to be repealed (this chapter was added in
1976).
2. 1948 factories act – This must be simplified to reduce labor costs.
3. Trade unions act 1926 – This law allowed 7 workers to form a union. A 2001
amendment introduced the qualification that unions should include 10% of the
workforce or 100 workers. This should be amended further according to the author.
India’s trade union density is only 13.4% according to ILO.