Structural Changes in India’s labour markets

India is midway through its demographic dividend – a period of time when demography gives economic growth a boost by expanding the working-age share of the population.To exploit this dividend and meet the growing aspirations of those entering the labour force, India’s economy needs to create enough “good jobs” – jobs that are safe and pay well, and encourage firms and workers to improve skills and productivity.

Employment growth between 1989 and 2010

There are two notable things of employment growth between 1989 and 2010.

First, informal firms account for most employment growth and nearly all the increase in the number of establishments since 1989. Out of the 10.5 million new manufacturing jobs created between 1989 and 2010, only 3.7 million (about 35%) were in the formal sector. With respect to number of establishments created between 1989 and 2010, formal sector accounted for only 1.2 per cent of the growth. Here, informal firms are those which have little or no contact with the government.

Second, after 2000, informal sector establishment counts flatten and employment actually falls, while formal sector employment picks up.The possible reason could be the increasing use of contract labour.

But in comparison the informal sector jobs are much worse than formal sector jobs. Wages are, on average, more than 20 times higher in the formal sector, though informal sector wages have grown somewhat faster between 1989 and 2010. Formal sector jobs are also better on some non-pecuniary grounds. For example, they allow workers to build employment history – which is important for gaining access to cheaper formal credit. Therefore the challenge is to create more jobs in formal sector.

What are the three main developments in labour markets?

• Contractualisation of labour,
• Competitive federalism, and
• Relocation of labour-intensive manufacturing to second tier cities and towns.

The rise of contract labour firms

In a recent survey, medium-sized formal sector manufacturing firms reported labour regulations to be a significant barrier to growth, and specifically “dismissal norms under the Industrial Disputes Act (IDA)”. Numerous regulations also encourage rent-seeking behaviour. Higher rents results in lower growth in formal employment and higher future growth in informal sector employment.The number of contract workers has increased from 12 per cent of all registered manufacturing workers in 1999 to over 25 per cent 2010.

There are two benefits in hiring contract workers: first, the firm essentially subcontracts the work of following regulations. Second, because contract workers are the employees of the contractor and are not considered workmen in the firm, the firm stays small enough to be exempt from some labour law. The IDA is applicable to plants with more than 100 workers.  As a result, large firms – previously the most constrained under labour laws – have benefited from the growth of contract labour.

Much of the large firms say that contract labour is not the ideal solution on account of two factors:

• Hiring workers through contract labour can be more expensive, and
• contract workers do not feel as much loyalty to the company as regular workers would reducing employers’ incentive to invest in their training.

There is also evidence that hiring contract workers today hurts a firm’s productivity tomorrow, precisely because contract workers do not accumulate “firm-specific human capital”.

‘Competitive Federalism’ and labour markets

With private investment lagging, states are under pressure to be seen as attractive destinations for investments that will create jobs and boost economic growth. Several states, such as Rajasthan, have responded by amending their labour laws with the goal of attracting large employers and high growth industries to their state, and other states like Gujarat and Maharashtra are considering steps in this direction.

There may be a possibility of competitive federalism becoming “too competitive”, inducing a race to the bottom with states pushed into giving too many concessions. But India seems far from such a situation. For example, changes that certain states are considering – such as Haryana’s proposed online filing of returns through a single form covering 12 separate labour laws and e-maintenance of all labour-related records—would likely improve compliance and worker welfare.

How to improve productivity in apparel industry?

Apparel is an industry in which India should be performing well. It is labour-intensive, with 30 per cent of costs from wages. Only 2-3 per cent of costs are due to capital-intensive inputs like power. And yet India is ceding market share in the global apparel industry to countries like Bangladesh and Vietnam.

It is suggested that productivity could be substantially improved by reallocating capital from less-productive to more-productive firms. Formal sector apparel firms are about 15 times more productive than their informal sector counterparts. Yet India’s apparel sector is dominated by informal firms. Much of this mushrooming is due to a very large increase in the incidence of 1-person apparel establishments in urban areas. Spatial mismatch between firms and workers might explain why formal sector apparel firms might find it difficult to expand. Due to constraints on account of high costs in cities, labour-intensive manufacturing became uncompetitive.

A new business model that some formal sector apparel manufacturers are adopting is relocating to second- and third-tier towns and cities. This business model of moving factories to workers has a number of commercial and social advantages – it involves spreading economic development to underdeveloped areas, reduces spatial mismatch in the labour market and can improve competitiveness by raising firms’ access to lower cost labour.The apparel manufacturers locating in rural areas can help address the low rates of female labour force participation that prevent India from achieving its full economic potential.

Thus the “relocation” model could be termed a win-win-win: commercially advantageous for the manufacturer, bringing women into the labour market, and boosting growth. The industries similar to apparel industry can go for “relocation” model.

What is the Centre’s role in creating “good jobs”?

One key role of Centre is to ensure that labour regulation is worker-centric, by expanding workers’ choice and reducing mandatory taxes on formal sector employment.