Can Modi Tackle India’s Labor Pains?

Can India get back on economic track? Not if the new government of Narendra Modi will not take on the nation’s labyrinthine and archaic labor laws that have been strangling the Indian market, stifling job creation and suppressing manufacturing. But there is hope: Last month, the labor ministry invited public comments to reform two major laws that affect minimum wages and work conditions in factories, which they are now discussing behind closed doors. As a promise to boost economic growth through manufacturing and job creation in last week’s national budget for the year, this is a welcome move.

After decades of deadlock, if there is any hope for labor reform, it is now. Modi’s center-right Bharatiya Janata Party (BJP) enjoys a popular mandate to push politically difficult reforms; the BJP is the first party to win majority seats since 1984 in the Parliament’s lower house and the first non-coalition government since 1989. This year’s election also annihilated the left-wing political parties – especially the bloc of communist parties whose hold was reduced to the lowest ever vote share of 4.6 percent – allowing more reform discussion. But Modi is not taking his lock on political power for granted; the first steps toward labor reform have been worker-oriented, preempting – perhaps – a major labor union backlash. For instance: bringing more workers under the minimum wage, increasing overtime hours, and allowing night shifts for women.

Here is the problem: Current labor law in India is convoluted, restrictive, and archaic, much of it dating to the Raj (“British Rule”). About 50 central laws overlap with 150 state regulations. The clauses for the Industrial Disputes Act (IDA) of 1947, a major law that covers industrial disputes irrespective of firm size, were conceived under the British. Over time, the IDA has evolved, and now mandates that firms with more than 100 workers (originally 300 or more) obtain government permission to fire workers. Nervous about complying with tough restrictions, employers usually opt to remain small and off the books. As a result, about 93 percent (400 million) of the Indian workforce is employed in the informal sector.

Modernization of the labor market is a key ingredient for India’s transition from agriculture to high-productive manufacturing and a shift to urbanization. In the 1970s, the share of manufacturing to GDP was around 12 percent. After barely rising over the years, this share fell again to 14.6 percent in 2012-2013, the lowest in 20 years. Only 30 percent of Indians live in cities, compared to 50 percent of the population in China or Indonesia. Economic growth, halved since 2010, hovers at 5 percent this year; the contribution of manufacturing to GDP is still lackluster.

This mish-mash of labor laws imposing harsh hire and fire restrictions give no incentive to employers to transition to the high-production formal sector. Last year, a World Bank study confirmed that larger (100+ workers), formal sector firms innovate more, and compete in export markets, especially in the presence of foreign competitors. India misses out on such economies of scale: research by Rana Hasan and Karl Jandoc in 2012 showed that about 84 percent of manufacturing firms in India are small firms employing less than 49 people. Only 11 percent employ over 200 people (“large size”); whereas in China large-sized firms account for 52 percent.

India is also amongst the most difficult places to do business. The World Bank’s Doing Business index shows India falling down three places to 134th this year, the worst performing country in South Asia after Bhutan and Afghanistan. Growth of India’s manufacturing sector is waning, barely touching 15 percent. To meet the goals of the National Manufacturing Policy (NMP) – which strives to boost the share of manufacturing to GDP to 25 percent and add 100 million jobs by 2022 – strong labor law reforms are needed now to put India on the path to create what Goldman Sachs calculates as 110 million jobs needed by 2025. This would also help to absorb the 12 million Indians who join the workforce every year.

In short, Modi has a daunting task before him. But the good news is that he also has the political capital to do it. A shrewd politician, it appears clear Modi recognizes the need to tackle the low hanging fruit – the easiest reforms – and then move on to the greater challenges. These are plentiful.

Politically, the most difficult option for Modi will be amending the legislation for more flexibility. Perhaps the most crucial reform of all is to fix the IDA, and the limitation on layoffs for organizations with 100 or more workers; a 2013 study shows that Pakistan and Sri Lanka are the only countries besides India that require approval by public administration before undertaking any dismissal. A host of other smaller changes, including relaxing restrictions on working women and archaic demands on factory owners, is required. However, each of these changes requires a constitutional amendment.

A less difficult, and more logical, scenario would be to fully authorize states to pass reforms. In a rather inefficient arrangement, labor laws currently fall in the “concurrent” list – which means that labor laws can be amended by the center or the states. But there is a strong case to be made to transfer all authority to individual states mainly because the lack of clear responsibility encourages inaction, unaccountability, and free riding. Performance-driven states are punished and complacent ones are rewarded. For instance, states like Andhra Pradesh, Gujarat, Karnataka, Madhya Pradesh, and Maharashtra wish to make labor laws flexible by allowing choice and opportunities for employees but have been shot down from Parliament. However, moving labor laws from “concurrent” to the “state” list will require a legislative amendment backed by the use of significant political capital. Modi’s affinity for decentralization (as former chief minister of Gujarat state) increases his potential to push for decentralizing labor laws. His only obstacle is to convince the Parliament’s upper house (Rajya Sabha), where his party does not yet have a majority.

An easier option, considering the new government does not yet enjoy a majority in the Rajya Sabha, is for states to seek Presidential assent directly to amendments proposed by state legislatures when repugnant to existing Parliamentary legislation. In a potentially far-reaching move, the new BJP-led government in Rajasthan has recently adopted this route. Rajasthan state’s legislature cleared amendments to three labor-related acts and these are now sitting with the President of India for his nod. The state has proposed changes to IDA so that permission for retrenchment is only required for firms employing 300 or more people. The state legislature has also introduced a three-year time limit for raising disputes, and trade unions cannot be registered without 30 percent worker representation (instead of the current 15 percent). Restrictions from the Contract Labor Act will apply only to companies with more than 50 workers, as opposed to the current 20.

The easiest reform option is for the central government to encourage individual states to unleash simpler procedural reforms. These could be reforms that do not require changes in law but simply initiatives to clarify and simplify multiple labor laws to enforce compliance. The “Mahashramm” initiative by the state government of Maharashtra provides online registration services for business as a one-stop shop and also reduces harassment from arbitrary government inspections. The state government of Gujarat has also pioneered labor law compliance relaxing clauses for appointment and termination of labor in special economic zones (SEZ). In fact, recent research by Goldman Sachs predicts that 40 million manufacturing jobs could be added to the economy if states made their labor laws as flexible as Gujarat. The state’s reform initiative brought a growth of 60 percent in manufacturing employment between 2000-2012 whereas complacent West Bengal saw only a 22 percent increase. Gujarat and Andhra Pradesh have also undertaken efforts to bridge the gap between education and labor skills with links between universities and skills programs. This not only encourages competition to attract investment from India and abroad, but also improves the general tendency of future reforms to stick.

Modi’s attempt to address India’s labor pains is a welcome change from the status quo. His government rightly recognizes that introducing reforms to benefit workers first should be brought about before attempting to make markets fully flexible. Such reforms will not only ensure more workers are in the formal sector, but also boost social security coverage to the 93 percent now in the informal sector. But it will not be all plain sailing for the new Prime Minister; plenty of experienced players are poised to fight every change, whether to protect unions, maintain a competitive edge or simply enjoy the status quo. One thing is for sure, however. If Modi and his majority cannot kick-start Indian labor markets now, no one can.

Hemal Shah is research associate for India Studies at the American Enterprise Institute in Washington, DC. She tweets @hemalshah_7. A detailed version of this essay will be published in the Indian Journal of Industrial Relations in August 2014.