Why Growth Matters (19 page)

Even if each of these and other central and state legislations are poorly enforced, they imply considerable burden on the smaller firms in terms of paperwork and filing requirements. Indeed, many firms are not even aware of their precise obligations under the large number of central and state legislations. Unwitting noncompliance in one or more areas is inevitable, especially for all but the exceptionally large firms, opening the door to corruption by labor department inspectors.

No discussion of labor laws would be complete, however, without including the 1947 Industrial Disputes Act (IDA). This important legislation covers all industrial disputes regardless of firm size. The disputes typically involve an employer and one or more of his workmen. But the act covers all other disputes as well, such as those arising between two or more workmen or between two or more employers. The act lays down procedures and defines the institutional infrastructure for resolving disputes. It also states the conditions under which employers can alter the tasks assigned to workers, conditions under which they can be laid off or retrenched, and the rules regulating strikes. Several key provisions stack the deck disproportionately against employers and must affect their willingness to hire regular as opposed to contract workers.

First, the IDA confers the power to regulate labor–employer relations on the labor department with jurisdiction over the firm, which is usually in the state where the firm is located. The legislation defines an industrial dispute as
any
dismissal, discharge, termination, or retrenchment of a worker in a firm of any size. The first step in settling a dispute is reconciliation, failing which it is referred to labor courts and tribunals that overwhelmingly rule in favor of workers on the theory that firms have deep pockets and workers do not. An attempt to reform the IDA for its anti-employer bias through alternative legislation in 1950 failed, and no subsequent attempt has been made.

Second, Section 9A of the IDA requires that the employer give three weeks' notice to workers of any change in their working conditions in all industrial establishments with fifty or more workers. These changes may relate to shift work; grade classification; rules of discipline; technological changes impacting the demand for labor; and employment, occupation, process, or department. The workers have a right to object to these changes, which may culminate in an industrial dispute.

Third, and most important, Chapter VB of the IDA effectively makes it impossible for an industrial establishment with one hundred or more workers to lay off or retrench workers even if it is unprofitable and is therefore forced to close the unit. This chapter was first introduced in 1976 and initially applied to industrial establishments with three hun
dred or more workers. Later a 1982 amendment, which became effective in 1984, reduced the threshold from three hundred to one hundred workers. Establishments subject to the regulation must seek permission from the labor department with jurisdiction over the firm for any layoffs and retrenchment. Concerned labor departments rarely give such permission even when the unit is unprofitable and must be shut down. The owner is effectively required to pay the workers from profits in other operations in case of closure. Few countries have a parallel to this provision in their labor legislations.

The final labor legislation of importance is the 1970 Contract Labor (Regulation and Abolition) Act. Contract workers are indirect employees of an establishment: they are hired, supervised, and paid by a contractor who has in turn contracted with the establishment to deliver certain services in return for a specified compensation. The establishment has no direct responsibility to contract workers; indeed, he need not even know who these workers are. Typically the contractor hires the contract workers for specified tasks and duration. While economic factors justify use of contract workers under many conditions, factories and establishments also prefer contract workers to avoid the burden imposed on them by the onerous labor laws.

The 1970 Contract Labor (Regulation and Abolition) Act attempts to limit this erosion of legislative requirements. It aims to regulate the employment of contract labor in certain establishments and to provide for its abolition under certain circumstances. It applies to establishments employing twenty or more workers and to contractors employing the same number of workers. Several of the provisions in the act are aimed at protecting the interests of the contract worker. But a key provision gives the government with jurisdiction over an establishment the power to prohibit it from using contract labor for work of perennial nature or work that is central to the manufacturing process. The government is also empowered to deny the use of contract labor for a task if other similar establishments use regular workers for that same task. Many states have used this provision to ban the use of contract labor in entire sectors.

The burdensome labor laws explain why entrepreneurs in sectors such as apparel, in which labor costs account for more than 80 percent of the total costs, choose to stay tiny. The costs due to labor legislations progressively rise in discrete steps at seven, ten, twenty, fifty, and one hundred workers. It is not altogether implausible that as the firm size rises from six regular workers toward one hundred, at no point between these two thresholds is the savings in manufacturing costs sufficiently large to pay for the extra costs of satisfying the laws. It may well be that only at a very large scale the cost savings can pay for the costs of labor laws. Under such circumstances, we will end up with either tiny or very large firms, with the middle missing, as has been the case in India to date. But when it comes to the labor-intensive sectors, extremely few firms seem to find it attractive to operate at any scale other than the tiny.

Ajay Shah of the National Institute of Public Finance and Policy tells an interesting story highlighting the dilemma of Indian entrepreneurs considering entry into labor-intensive sectors.
¹³
Some years ago, he asked a leading Indian industrialist, “You're a smart guy; you saw the [multi-fiber arrangement, or MFA] quota regime going away. Why did you not make a big play for it, given that you were already in yarn and cloth?” The industrialist replied that with low profit margins in apparel, this would be worth his while only if he operated on the scale of 100,000 workers. But this would not be practical in view of India's restrictive labor laws, added the industrialist.

Nonetheless, some analysts remain skeptical of the argument that labor-market rigidities are at the heart of the absence of the midsize and large firms in the labor-intensive sectors. These analysts offer several alternative arguments in support of their position.

They blame a lack of adequate literacy among potential workers. According to them, even the so-called unskilled tasks, such as cutting, sewing, stitching, and packaging garments, require a level of literacy that is lacking in India. This claim is false. For one thing, tailors currently employed in smaller establishments, of which India has plenty, fulfill multiple tasks. They are surely capable of repeatedly performing one or
more of these same tasks in a factory setting. Equally, the India-wide gross enrollment ratios in education decisively contradict the claims of insufficient literacy.

Another counterargument relies on the observation that female workers have predominantly populated the large-scale factories in labor-intensive sectors in countries such as China. According to this argument, social attitudes and the legal framework in India do not support the employment of women in large factories.
¹⁴
Thus, for instance, families are reluctant to send womenfolk to work in factories, and laws such as the 1948 Factories Act prohibit the employment of women in night shifts that last from 7 p.m. to 6 a.m. Once again, the basic premises behind this argument are faulty. There is no reason why men could not be employed in apparel, footwear, and toy factories. As for the employment of women, while it is desirable to amend the Factories Act to permit them to work night shifts, even under the current law, they could be employed during the day shift with men assigned to night shifts.
¹⁵

Some argue that labor-intensive products, most notably apparel, require just-in-time delivery to export destinations such as the United States and Europe. There is seasonality in demand for clothing and accessories, and the bulk buyers such as Walmart require delivery according to very tight schedules. Such delivery in turn requires first-rate infrastructure. Any delays due to unreliable links between the factory and the port, for example, can result in a loss of the order. Indian infrastructure is simply too unreliable to fulfill such prompt delivery. But while there is some truth in this argument, infrastructure is not a binding constraint everywhere in India. Gujarat has put in place excellent infrastructure including ports that load and unload goods proficiently and expeditiously. While poor infrastructure in some states may contribute, it alone cannot explain the absence of large-scale labor-intensive manufacturing in every state.

Others argue that growing beyond the small size requires access to credit, which most firms aspiring to grow large lack. But this argument is also falsified by the fact that both medium and large firms account for a much larger employment in the capital-intensive sectors, such as motor vehicles and auto parts, than in the labor-intensive sectors, such as apparel (see
Figure 8.3
). Unless something else, such as the labor laws, has made
apparel a riskier business than motor vehicles and vehicle parts, there is no obvious reason why the banks would discriminate in favor of the latter in a labor-abundant country.

It is also argued that when interviewed for business environment surveys, firms rarely point to labor-market rigidities as the key problem. But this phenomenon is wholly misleading; it is the result of what economists call a “selection” problem in the sample of firms surveyed. Midsize 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 sample. Large firms in the sample surveys also typically come from either the service sectors or the capital-intensive manufacturing sectors. Services firms are not subject to some of the most constraining labor laws, such as Chapter VB of the 1947 Industrial Disputes Act, and therefore are unlikely to point the finger at them. Indeed, many of their employees probably do not even qualify as “workmen” under the 1947 Industrial Disputes Act. As for the large firms in the capital-intensive sectors, their labor costs are less than 10 percent of the total costs and they have high profits per worker, making it worthwhile to bear the costs of labor-market rigidities. They can handle even the problems of layoffs through voluntary retirement in return for golden parachutes. Large firms in the labor-intensive sectors in which labor costs are 80 percent of the total costs and profits per worker are low do not have this option.

Some suggest that while labor laws may be onerous on paper, they are not enforced or that firms can get around them. However, 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 they are not able to get around these laws in a cost-effective manner. Being able to get around does not mean getting around at low cost. After all, the firms had also learned to get around the import and investment licensing and high trade barriers before reforms began in earnest in 1991. But we now recognize that they did so at a huge cost, that only a few of them were able to do it, and that the country paid a huge cost for the regulations in terms of low growth for four decades.

An example of how rigid laws, combined with an overburdened judiciary, can be highly costly even to large firms in the capital-intensive sectors is provided by the Uttam Nakate case. The following succinct summary of the case from Sanjeev Sanyal (2006) is instructive:

In August 1983, Nakate was found at 11:40 am sleeping soundly on an iron plate in the factory in Pune where he worked. He had committed three previous misdemeanors but had been let off lightly. This time his employer Bharat Forge began disciplinary proceedings against him, and after five months of hearings, he was found guilty and sacked. But Nakate went to a labor court and pleaded that he was a victim of an unfair trade practice. The court agreed and forced the factory to take him back and pay him 50% of his lost wages. Both parties appealed against this judgment (Natake wanted more money). The case dragged on through the judicial system for another decade and in 1995 another court awarded Nakate more money because he was now too old to be rehired. Bharat Forge eventually had to approach the Supreme Court and in May 2005—more than two decades after the original incident—the apex court finally awarded the employer the right to fire a worker who had been repeatedly caught sleeping on the job. (p. 9)

Surely this “getting around” was a costly affair for Bharat Forge.

A final counterargument offered is that labor-market rigidities apply to only a tiny section of the labor force. In this view, the fact that more than 90 percent of the labor force is in the informal sector or employed informally in the formal sector implies that the bulk of the labor market is highly flexible despite the ill-designed labor laws. However, this is a rather disingenuous argument. After all, the entire debate is about the smallness of Indian firms and, in particular, the absence of medium and large firms in labor-intensive sectors. This argument begs the question of why such a small part of the labor force has found formal employment in India.

In their search for the causes of the near-absence of large-scale firms in the labor-intensive sectors, Hasan and Jandoc (2012) turn to state-level differences in policies and outcomes. They first compare the firm-size distributions of all manufacturing between states with flexible labor regulations and those with inflexible ones and find almost no cross-state differences. However, when they restrict the sample to labor-intensive manufacturing, large-scale firms exhibit proportionately significantly larger shares of employees and small-scale firms a significantly smaller share in states with flexible labor regulations (
Figure 8.4
). Given that labor laws remain highly restrictive even in the states classified as relatively more flexible, and thus hinder the emergence of medium-and large-scale firms in greater proportion, the existence of these state-level differences is particularly significant.