‘Relaxing Labour Laws Can’t Help Industry In The Long Run; Formalising The Economy Can’

New Delhi: The ongoing lockdown to contain the spread of COVID-19 has exposed an already simmering migrant crisis. Unprecedented in history, the pandemic brought to halt a nation of 1.3 billion people overnight, leaving its largest, but often invisible, workforce stranded, hungry, stigmatised and angry.

After the imposition of the lockdown on March 25, 2020, India’s estimated 120 million rural-to-urban migrant workers were either stranded at their place of work or poured out of cities onto highways to walk hundreds of kilometres to reach their villages (read our stories here, here and here).

To add to the workers’ woes which stem from the informal nature of their jobs, some Indian states are further relaxing labour laws to attract investment and propel industrial activity stalled due to lockdown. But this move will badly impact the living and working conditions of labourers, specially in the informal sector as they already have no financial and social security.

Though firms seemingly have an upper hand if labour laws--which protect workers’ rights--are relaxed, in reality, as a result of weak labour laws, firms will have to work with labour that “owes no allegiance to the organisation”, says Errol D’Souza, professor of economics and director of Indian Institute of Management (IIM), Ahmedabad. Thus, the dilutions in laws will end up making these organisations invest more in monitoring and enforcement to obtain productivity from precarious employment, says D’Souza, who is also a director of Shram Sarathi, an Udaipur-based non-profit focused on helping migrants, in an interview with IndiaSpend.

While the migrant workers’ plight has its roots in the informal nature of their jobs, which leaves them devoid of legal and social security, to understand the scale of this crisis, it is useful to remember that nearly 92% of the 61 million jobs created over two decades post-liberalisation, have been informal. This must change if India wants to protect its workers against COVID-19-like economic shocks, says D’Souza.

The informal sector and its workers, mostly migrants, “were ignored” in the Indian government’s decision to lock down the economy and such neglect, while making decisions, stems from “a groupthink bias that permeates policy-making circles which are not inclusive”, he says.

D’Souza, who has served on many government committees, and has been associated with the Planning Commission of India and the Reserve Bank of India in various capacities, including as a member, Technical Advisory Committee on Monetary Policy, says a formalised economy would be able to secure the livelihoods of its workforce through the prevalence of institutions that mitigate the impact of shocks. Post COVID-19, India needs to start moving towards formalising its economy, which will improve the quality of jobs and life for millions of its workers, he says.

Edited excerpts:

After a hiatus in industrial activity due to nationwide lockdown, many Indian states, Uttar Pradesh taking the lead, are either diluting or getting rid of a range of labour laws to attract investment and revive industries. What will be the implications of such a move?

The states of Uttar Pradesh and Madhya Pradesh have relaxed certain labour laws [for a stipulated period of time] such as allowing longer working hours, laws on occupational safety and working conditions, and the minimum wage. UP has initiated the change in labour laws after queries by Japanese firms that are looking at moving their investments out of China. Supply chains across the world have been reorganised due to dynamic consumer demand and short product life-cycles as firms provide thinly differentiated products with small functionality changes and indulge in new product introductions and rapid product phase-outs. This requires a system that is lean in that it allows quick scaling up or down of production. Firms, then, search for flexible employment practices with corresponding issues of safety and variable working hours and benefits.

The way to counter this is to move beyond employment contracts that make only those who directly contract with the worker as responsible for their work conditions. Joint liability provisions are required. These are prevalent in some countries such as France, which in 2017 mandated an obligation for French parent and subcontracting companies to identify risks to health and safety and violations of human rights and take steps to mitigate them. Interventions not focused solely on the locus of production but on the retailers and making them jointly responsible for workers--such as the Bangladesh Accord after the collapse of the Rana Plaza in 2013 that housed garment factories--have better chances of protecting workers.

Many firms do not realise the benefits of laws protecting workers. A good example is a severance payment required to be paid on firing. This does not involve a burden to a firm as usually the firm will structure it in such a way that the worker is made to pay a premium with a wage reduction and the worker is paid back at the time of termination. This, then, acts like an insurance against employment risk and is not costly to the firm. Or requirements such as advance notice of dismissal. By lengthening job tenure, it allows workers to search for employment while on the job and to enhance the possibility of transition to another job without loss of income and unemployment.

Similarly, minimum wages have usually been set high (way above median wages) by policy makers in order to substitute for the weakness of collective bargaining institutions. The result is that more than 40% of workers are paid less than minimum stipulated wages and it has adverse effects on the lower-skilled workers in the labour force as firms reduce vacancies and attempt to substitute with more casual labour. Labour laws are important because they have a distributional objective and improve the bargaining power of workers as they serve as a reference point in wage and working condition negotiations. Diluting them may seem to provide an upper hand to firms, but it will result in them obtaining labour that owes no allegiance to the organisation and will end up making them incur higher monitoring and enforcement costs to obtain productivity benefits from precarious employment.

Over 90% of the total Indian workforce is ‘informal’, according to the Economic Survey of 2018–19. It is commonly believed in India that strict labour laws compel firms to operate informally. Is this notion correct? Are there other reasons that push people to work in an unorganised sector?

It is the case that more stringent labour regulations are associated with lower formal-sector employment and higher informal-sector employment. There is no effect on unemployment, which in India is usually low and hardly varies as the decrease in formal employment results in a compensating increase in the informal-sector employment.

Regulations that govern firing rigidities and dispute-resolution mechanisms--which favour employees--are known to be hindrances in formal employment. Legal provisions on the length of notice period and the extent of severance pay, depending on tenure, affect the likelihood of formal employment. How dismissals are to be communicated and who is to be notified in order to carry out a dismissal (such as the conciliation officer or labour court and industrial tribunal) are also influencers of formal employment.

An important issue in India is not that legislation is prohibitive and inhibits employment, but that the legislation may never be enforced, or may be enforced unevenly. The key issue is inefficiencies in civil justice systems, leading to lengthy trials with uncertain results. Since employers are unable to rely on the formal legal mechanism, they prefer to work with contractual labour or informal labour.

Do you think COVID-19 and the resultant economic crisis is a sign to move towards formalising the economy?

The reason the informal sector was ignored in the decision to lock down the economy is a groupthink bias that permeates policy-making circles that are not inclusive--the bias arises because we do not obtain information about those not like us when we rely on cues from those around us. When folks around us are not affected by something--when we are contemplating public action--then we are blind to the effects of that action on the marginalised. The COVID-19 disruption will not provide an occasion towards making the regulatory changes that will formalise the economy given the bias of policy makers against the underprivileged.

There is an important lesson we can learn about the opportunistic behaviour of informal-sector employers as the lockdown was announced. Rather than using it as an opportunity to invest in long-term goodwill, and to elicit willing labour effort once business resumed, many workers were informed that the business had shut down and that they would be paid their dues only when the work would resume. Some were made to sign resignation letters and some received expulsion notices by SMS [on their phones].

How can a better-formalised economy prepare India to deal with unforeseen economic shocks--such as the one caused by the lockdown due to COVID-19--that can upend the lives of migrant workers overnight?

To understand how a better-formalised economy operates, it is useful to think of how households deploy wealth-creating assets to produce income and other aspects of well-being, which are constitutive of livelihoods.

The wealth-creating assets that households are endowed with unequally are various forms of capital--physical, financial, human and social. Physical capital encompasses land, housing, livestock, jewellery, farm implements and other production durables that constitute tangible assets that allow production and have the potential of begetting income. Financial assets allow households to make intertemporal adjustments [adjustments over time] of income that can be used for consumption, production and investment. There are three types of financial capital services that are useful to a household--savings services, credit services and insurance services. Human capital includes health, education and nutrition that are embodied in individuals and which translate into skills and abilities that are potential sources of labour, managerial and entrepreneurial incomes. Social capital refers to the features of social organisation such as informal reciprocal networks, norms and trust that are found within communities and extended families, and which facilitate coordination for mutual benefit or enable redistributive transfers to occur. 

These capital assets of households are subject to erosion due to stochasticity--various types of eventualities that are probabilistic in nature and beyond the direct control of households. These stochastic events are of four types, each of which yields variable and unpredictable returns from capital and so affect the security of livelihoods.

One type of stochastic fluctuation can be characterised by frequency of occurrence. Certain types of shocks to human capital such as minor illnesses, for instance, can occur frequently whereas other shocks are relatively rarer. High-frequency downside shocks have the potential to erode capital and can be quite damaging. Second, there is the intensity of occurrence of a shock, more intense shocks being more serious or damaging to the asset base of households. For instance, a shock of high frequency but minor incidence to health, such as an insect bite, will have a lower impact than the one with low frequency but serious impact, such as a coronary attack. Third, shocks need not be independently distributed over time--they could be autocorrelated. For instance, a monsoon failure may result in drought and malnutrition which, in turn, raises the probability of occurrence of further erosion of human capital as children are pulled out of schools and made to work to supplement the reduced income. Droughts also affect the maintenance of land, and, the consequent poor soil conditioning and run-offs, can have adverse impacts much after the climate returns to normal.

Some shocks may be non-stationary. For instance, if somebody becomes permanently disabled or loses productive assets, then these can have permanent effects on their capacity to generate income. The fourth type of random shock does not vary over time but across individuals. These are either idiosyncratic, i.e., they are due to factors that are specific to individuals [and occur] in isolation such as accidents, injuries and illnesses, or they are covariate and affect a group who are linked geographically or by some shared risk characteristic such as floods, a drought or an epidemic.

A formalised economy is able to deal with these multiple impacts through the prevalence of institutions that mitigate the force of shocks--which deplete stocks of capital and reduce workers’ productivity--and thereby enable secure livelihoods.

In a bid to move towards formalising the economy, what are the important steps that the government should take?

It would be appropriate to think of the informal sector as construing production and employment that takes place in unregulated enterprises, and the employment that is without legal and social protection. Formalisation is about receiving the benefits of operating formally and not just obtaining licences or simplified registration procedures as an enterprise, which are, for those operating in the informal sector, the costs of participating in the formal economy.

The steps that will improve the benefits of functioning formally and elicit voluntary participation in this mode of operation include enforceable commercial contracts, legal ownership of the place of business, and clear bankruptcy rules against creditors. For workers in the informal sector, it is about formalising their jobs with secure contracts that are enforceable, have occupational health and safety measures, and employer contributions to health and pensions.

A significant characteristic of the economy that prevents formalisation is social exclusion, which refers to the multi-dimensional character of deprivation due to the disadvantages relating to the precariousness of work, income, gender, ethnicity and participation--it thus refers to exclusion in the economic, social and political sphere due to power relations, culture and social identity.

Social exclusion makes it very difficult for certain social groups to access resources such as education, information, credit, employment opportunities and legal protection that enable upward mobility. In India, one of the dominant forms of social exclusion is caste which is fixed at birth. There is still evidence that children from the lower castes are discriminated against in schools. Workers in the informal sector also suffer from social exclusion--being excluded [thereby] from the process of economic development [also]. The provision of social and economic infrastructure must be tied to a delivery mechanism that entails equal access to goods and services, such as basic health and education.

Social-security programmes for the unorganised sector should be designed to provide adequately to beneficiaries--with the adequacy of provision being a replacement (mainly partial) of previous earnings due to the occurrence of a contingency, or, the provision of a minimum or standard level of benefit to all.

The definition of social security needs to be broadened--from focus on addressing only contingencies to encompassing programmes that enable individuals to attain a reasonable standard of living. Those programmes that provide employment, income and assets--required to reach a basic standard of living--have been termed as economic-security programmes whereas those associated with needs such as healthcare, childcare, old-age pensions, and food have been termed as basic-needs programmes. These two types of programmes are mutually reinforcing.

For instance, childcare facilities can increase the productivity of women workers as well as their number of working hours; the increased income earned provides economic security that, in turn, becomes the means by which people can satisfy basic needs. Social security in an economy with a large unorganised sector must be seen as a part of a comprehensive poverty-reduction programme, which has a promotional component of improving endowments, and exchange entitlements as well as a protective component that shields individuals from contingencies such as illness, disability, etc. 

Micro, small and medium enterprises (MSMEs) have been considered engines of growth in our economy. With around 63.4 million units throughout the geographical expanse of the country, MSMEs contribute around 6.11% of the manufacturing gross domestic product (GDP) and 24.63% of the GDP from service activities as well as 33.4% of India’s manufacturing output. The sector, which employs most informal workers, however, does not provide good-quality jobs. Do you think the importance that country’s MSMEs are accorded, in relation to growth, will have to change? How? What would be some of the key actions required here?

The Economic Survey of 2018-19 showed that the contribution of small firms to output and employment (15% share) is insignificant in manufacturing though they account for 85% of all firms. These firms tend to utilise reservation policies [indicated below] that benefit them and it results in them staying incentivised to remain small and not contribute to the creation of employment opportunities.

Any incentive policy should have a sunset clause that ends after a period--say, 10 years. By then those that benefit from a policy should be able to find the means to be sustainable. Some policies that should have sunset clauses are the following:

• Priority Sector Lending and lending at interest-rate subvention.
• Purchase Preference Policy that allows for a group of items to be exclusively purchased from small firms.
• Price Preference Policy where, for selected items, a price preference to a 15% premium over the lowest quotation of the large-scale firm is to be allowed.
• Other policies, such as ‘marketing assistance scheme’ for market promotion activities and ‘raw material assistance scheme’ for financing the purchase of raw materials and the ‘GST composition scheme’.

How are entrepreneurs--who have the responsibility of creating jobs--in the Indian economy different than those in advanced economies? Since the government is also trying to promote entrepreneurial spirit through several schemes, including Startup India and Stand Up India, what are the conditions most conducive for such individuals and firms?

Most entrepreneurship in India is that which is visible in small enterprises that consist of self-employed persons or, at best, a few employees. These entrepreneurs are there by necessity due to a limited number of wage-paying jobs. In an advanced economy, by contrast, becoming an entrepreneur is a choice made to gain the returns available from a perceived opportunity. Such entrepreneurs transform business and provide valuable job creation. Healthy regulation with sunset clauses--as described above--promotes the entry and maturity of such entrepreneurial firms whilst protecting their customers and workers from unscrupulous and exploitative actions.

A significant factor in small firms not having entrepreneurs who pursue profitable new opportunities--via developing new products or processes--is their lack of high-quality formal education. An important determinant of productivity is tertiary education and its associated managerial human capital. Informal firms are not productive because of the low level of human capital of the entrepreneurs who run them. This lack of human capital affects how banks see them. Formal financial institutions would more easily lend to skilled entrepreneurs who have some form of third-party verifiable managerial control systems such as books of accounts.

It is the shortage of educated entrepreneurs that is the most significant limitation on entrepreneurship and the growth of small firms. The availability of finance would be the next important limitation. Of lower order in importance, though not trivial, would be licensing, corruption, and the legal system.

The schemes promoting entrepreneurship are focused only on the generation of new types of businesses while ignoring that their [businesses’] ability to scale up and become sustainable depend on the human capital of the entrepreneurs apart from the availability of venture capital and private equity funding. 

(Tripathi is an IndiaSpend reporting fellow.)

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