Which labour reforms will make a difference?

July 4, 2014

Martin G. Rama, World Bank's Chief Economist for the South Asia Region The Economic Times

Labour policy reform is a priority for India's new government. Recently, Vasundhara Raje, chief minister of Rajasthan, announced changes to three pieces of labour regulation. Almost at the same time, the ministry of labour called for opinions on how to amend a number of labour-related legislations.

With almost one million entrants to the workforce every year, India needs huge job creation. Not any jobs, but those that will take India's aspiring youth to middle-class living standards.

So far, creation of modern, formal sector jobs has been confined to dynamic sectors like business processing outsourcing.

But these jobs cannot absorb such numbers. And they are out of reach for the majority of young people with less than complete secondary education. For them, the hope is formal employment in light manufacturing industries or in modern retail.

Whether India's labour regulation has impeded the creation of more formal jobs in labour-intensive sectors has been hotly debated. The World Development Report 2013: Jobs undertook a thorough review of empirical analyses on the effects of minimum wages, mandated benefits, social insurance and collective representation around the world.

The picture that emerged was one of a "plateau" with a cliff at each end. Both extreme flexibility and extreme rigidity are associated with poor economic outcomes. The review also highlighted that more "pro-labour" regulation tends to benefit workers who have a job at the expense of capital owners.

But it also tends to favour male middle-aged workers over women and younger workers. Interestingly, South Asia is wellrepresented at both ends of the "plateau". The Rana Plaza tragedy in Bangladesh is an example of the damage triggered by the neglect of basic health and safety standards. India appears to be off the other cliff. But this is not so across the board.

Minimum wages represent about 28 per cent of average wages in India, compared to 29 per cent in China and Vietnam, 34 per cent in Malaysia and 38 per cent in Brazil. Work hours are capped at 48 per week, the same as in Malaysia and Vietnam, but substantially above the 40 allowed in China and Russia. And paid maternity leave — at 12 weeks — is shorter than in most comparator countries: Colombia (14 weeks) and Brazil (17); only in Malaysia is maternity leave shorter. India stands out in its procedures to dismiss workers. 

The issue is not the level of severance pay. Firms are required to pay separated workers half a month's pay for every year of continuous employment, less than in comparator countries. But only India requires firms to seek government permission before dismissing individual workers. Complex, time-consuming and non-transparent dispute resolution procedures add to dismissal costs.

And norms are far stricter for firms with 100 workers or more. Large firms must notify workers three months bef before dismissal, regardless of the worker's tenure. And claims of unfair dismissal can be made until three years later.

Moreover, firms are obliged to pay wages during the sometimes endless period of dispute proceedings. There is merit in simplifying India's labour regulations. With 44 national laws and hundreds of state-level amendments, the cost of compliance may simply be too high. Moreover, such complexity almost invites corrupt behaviour by both labour inspectors and firm managers.

But revamping such a massive legal architecture could easily become controversial, as was the case before. Even if the revamping were to succeed, it is bound to be a lengthy process and the demographic wave will not be waiting. India needs jobs now! Hence, our practical suggestion: to exempt all new formal sector hires, regardless of firm size, from the restrictive aspects of Chapter V in the Industrial Disputes Act.

This would give peace of mind to those currently employed — and the trade unions representing them — that their contracts are not being affected. It should also reassure firms that they can expand without being stuck with redundant labour if things go wrong.

And it will give newly-hired workers the same other benefits as formal sector workers: minimum wages, length of the work week, paid maternity leave, etc. This should be a reform without losers, hence without enemies. And it can be adopted without delay.

The writer is chief economist (South Asia region), World Bank. 
This opinion piece first appeared in The Economic Times on 4th July, 2014.