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Principles of Macro Economics

CIA-1

                                                                                              Raveer Singh Bajwa

Adverse Effect of Rigid Labor Laws in India

Introduction:

India is a country which contributes nearly 17% to the world population and only 3% of world GDP (Gross Domestic Product). The reason for our failure in achieving economic success on the global platform is due low levels of productivity, lack of education, infrastructure etc. But one element which is often ignored is the rigidity of labour laws in India. Recently under the BJP rule, the government doubled the import duties on products like toys, furniture, footwear, beauty aids and candles which shows the inefficiency of these labour intensive countries in our country. Moreover, there are evidences that India is more effective in Capital-Intensive Industries like leather, rubber and plastics chemicals etc. Even though India is known as a Labour Intensive these labour intensive industries are not able to perform due to the rigid labour laws in India which is the matter of study in this blog.

Labor Regulations in India:

The main reason India’s industries find capital-industry more cost effective than labour industry is the Labour Regulations of India. India has nearly about 200 labour laws, 52 of which are central acts, of these 3 acts that are the strictest are Industrial Disputes Act (IDA), the Industrial Employment Act, and the Trade Union Act. Under the Industrial Disputes Act (IDA), organisations with 100 or more than 100 employees have to seek permission of the government before laying off any worker from the firm. Such permission of laying off the worker is given by the government in rare circumstances, as a result of which firms tend to hesitate before employing too many workers as they will be stuck if the employee performs negatively in the organisation and is not as productive as required by the industrial standards. Further, the Standing Orders Act (Industrial Employment Act) requires industries with 100 or more than 100 employees to seek permission of the government for changing the job description of the employee i.e. reassigning the employee to other sector. Under the Trade Union Act of India any 7 employees can form a union within the organisation, which leads to emergence of several unions within the organisation leading to over use of the organisation’s resources. Under this act, these unions have the right to strike and represent organisation’s workers in legal disputes. Lastly under the Contract Labor Act, restricts and prohibits use of contract workers for certain tasks.

Effect of Labour Regulations on Industrial Sector’s Performance:

The impact of unnecessary labour regulations has been adverse on the performance of industrial sector. All the labour issues are in the “concurrent list” of the Indian Constitution i.e. both the Central and the State government can amend or pass the laws, with its implementation being solely in the hand of state governments and may vary among the states.

In the area of Labour Laws, pioneering work was done by Besley and Burgess (2004), by being the first one to quantify the state-level labour regulation in accordance with the amendments to the IDA. In their study they found that the state level manufacturing output, investment, and productivity went down in the formal sector and the same variables subsequently increased in the informal sector i.e. as the laws becomes more pro employee in the formal sector there is a spill over in the informal sector. The main reasons for this is unemployment generated in the formal sector leads workers to work in the informal sector.

Another study conducted by Hasan, Gupta and Kumar concluded that the output and employment growth in labour intensive industries is slower in states with restrictive labour regulations as compared to other states. Further micro studies conducted by Hasan and Jandoc found that in states having restrictive labour laws, 60% of labour intensive industries are concentrated in small firms having 0-9 employees whereas the same proportion is 40% for other states. The proportions for large firms employing more than 200 workers is 10% for rigid law states and 25% for others.

From these studies it can be understood that static and dynamic economies of scale can be effectively utilised in a market where labour laws are flexible resulting to increasing employment rates in those states.

Impact of International Trade on Industry’s Performance:

There is evidence that benefits from opening up our economy have been hindered by the restrictive labour laws. In a study conducted by Mitra and Ural (2009) which studied industrial performance measured by productivity, output, value added, capital stock, employment, and investment are improved by tariff reductions whose effect on productivity is 33% higher in states with less restrictive labour laws than those with rigid labour laws.

These laws also alter the effect of trade openness on informal sectors as these firms experience a rise in output, employment and value added rising from reduction in tariff rates in relatively restrictive labour law states. The main reason for this altering of trade openness is due to need of formal sectors to outsource their work to informal sector due to rigid labour laws.

Conclusion:

It can be concluded that labour laws are having an adverse effect on the manufacturing industry as a whole as it is pushing more firms towards small scale production as firms who want to produce less opt for small scale technology saving all the fixed costs of large scale technology. As firms with large scale technology require more workers and if the firm crosses 100 employees they will be under the IDA act as mentioned earlier. This has led to 2 adverse effect:

1. Firms are not producing the amount that they can afford to produce due to these restrictive laws.
2. Unemployment as firms opt for small scale production employing less workers even though when they have the resources to expand their business and employ more.

Secondly, due to higher power given to workers under the Trade Union Act, it usually leads to more conflicts within the organisation leading to wastage of time and resources of the organisation.

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