Decoding the plea for labour reform


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LABOUR market reforms have been a key component of policy pronouncements on economic reforms in India by multilateral institutions like the World Bank, corporate India and a section of economists since the 1980s. Labour laws in India, they argue, are too rigid and hence prevent firms from adjusting their labour requirements in response to shifts in product markets. A denial of flexibility in labour markets, therefore, impedes firms from competing efficiently in global markets which is critical to the new growth strategies pursued since the early 1990s. In particular, the focus has been on the ease of hire and fire, conditions to be met for recognition of unions and finally, the arbitration mechanisms for settling employer-employee disputes.1

The reforms demanded, therefore, fall under two distinct domains. One has to do with giving firms more power in the workplace to make appropriate adjustments to the size of the workforce. The second set of reforms aims to reduce the transactions costs of arbitration and dispute resolution. Here, I would like to point out that the call for reforms is not backed by sound empirical basis. Importantly, the theoretical basis on which the claims are made is too narrow to allow for imaginative policy interventions.

The rationale for labour reforms in India, however, goes beyond merely ensuring labour market flexibility and corporate efficiency. Many attribute perceived distortions in the structure of Indian manufacturing to the labour regime in place in the country. Better bargaining power through unionization made possible through labour laws is held to have led to higher labour costs due to higher costs of retrenchment and higher wages. Indian labour laws are, therefore, held responsible for higher capital intensity of production in manufacturing. Firms tend to replace high cost labour with capital and, as a result, generate fewer jobs than what is possible under more flexible labour markets. In other words, reforms are beneficial to both capital and those seeking to enter the labour market by expansion of employment and therefore ensure a more inclusive growth trajectory.

Further, some contend that it has led to what has been referred to as the issue of the ‘missing middle’ in Indian manufacturing. Industrial economists point to a relative absence of medium sized enterprises in Indian manufacturing. They point out that the structure is skewed, with a large number of small firms lumped at one end of the spectrum and a number of large firms at the other end with few mid-sized firms in between. Pro-labour law reformers attribute this skewedness and bimodal distribution of firms to a reluctance on the part of small firms to expand. Firms find ways of remaining small to avoid coming under the ambit of labour regulations. In turn, this behaviour prevents firms from taking advantage of economies of scale by investing in optimal expansion.


Despite the growing clamour for such change, especially in the wake of a relative lack of dynamism within the manufacturing sector vis-a-vis the services sector, successive governments have remained cautious on this front. Until a few months ago, there has hardly been any major formal reform of labour laws. Labour being a concurrent subject, a few state governments have made minor amendments like allowing women to work in night shifts and amended contract labour laws to enable firms to rely on a greater share of contract labour. Fear of a political backlash has been a major reason for this caution, Jenkins points out, forcing the Indian state to ‘reform by stealth’.2 Rather than push for big bang reforms, reforms have been pushed in an incremental fashion to avoid any negative political fallout. In other words, despite the contention that labour law reforms will benefit job creation, this is not an argument that the political elite has been able to sell easily.

Given the weakening of trade union power in the last decade or so, it is indeed surprising that the proposal to amend laws applicable to less than seven per cent of the workforce has been treated with such political caution. It is only now, with the coming to power of the current government enjoying an absolute majority in the Lok Sabha, that a set of formal measures have been initiated. At the Centre, the prime minister has unveiled measures such as computer generated random factory inspection schedules and simplifying procedures for compliance with labour laws to reduce what is seen as harassment by factory inspectors. The BJP-run Rajasthan government has come out with a set of formal changes which the central government is now showcasing as a model to be emulated.


There may not have been any major formal amendments to labour regulations until recently. Studies, however, highlight ways in which labour regulations have been steadily flouted in practice to ensure a degree of labour market flexibility far beyond what regulations allow.3 The voluntary retirement scheme (VRS) is one such example. The schemes are seldom voluntary. As the recent episodes of closure of the Nokia and Foxconn factories in Chennai reveal, workers were left with little choice but to opt for the scheme. When the scheme was first offered to the workers at Nokia, they were indirectly warned that their refusal to accept the offer would even deprive them of the compensation package.

Another example is the use of the Apprentices Act of 1961. Originally envisaged to involve the private sector in enhancing the availability of skills to meet the requirements of an evolving manufacturing economy, it is now mostly used to access a pool of temporary workers. Often firms do not retain anyone after the period of apprenticeship, replacing them with a new set of apprentices.

Further, firms employ workers as ‘trainees’ for a much longer period than actually required. In the case of Nokia factory again in Chennai, workers were employed as trainees for as long as three years when the skill requirements for working in the plant did not actually warrant more than three months. There are also extreme cases where young girls are recruited under the Apprentices Act in the spinning sector to work by the management under conditions of modern bondage which has been referred to as the ‘sumangali’ scheme.


Contract labour, originally meant for jobs that did not constitute core operations of a firm, is now invariably deployed in core operations as well. The Minimum Wages Act that is in spirit meant to ensure a subsistence living wage for a family of four hardly meets this requirement. In fact, in certain regions and sectors marked by relatively tight labour markets, such as the clothing and home furnishing sectors in Tamil Nadu, male workers are often found to opt out of regular employment as the regular wages seldom constitute a living wage. They prefer to work as casual workers earning piece-rated wages to ensure that their incomes are closer to that of a living wage.

Such dilution of the working of labour laws and standards of work has resulted in undermining the share of labour in income generated in the organized sector. The share of wages in gross value added has steadily fallen from 25.9% in 1980-81–1989-90 to 13.5% in the period 2000-01 to 2004-05 and further to 9.9% in the period 2005-6 to 2011-12.4 In fact, in the decade starting from 1999-2000, the bulk of additions to employment has come through informal employment within the formal sector, with the share of formally employed workers in the formal sector declining from 58% to 49% during this period.5 Based on analysis of data from various Annual Survey of Industries, Papola argues that contract labour that accounted for only 16% of all workers in organized manufacturing in 1999 has been steadily increasing over the last decade to 27% in 2004 and 33% in 2009-10. He emphasizes this growing flexibility further saying that, ‘Of the new workers employed during 2000-10, about two-thirds are employed through contractors, and are not on the payroll of enterprises either as permanent, temporary or casual workers.’6


Speaking on the condition of anonymity, an Assistant Inspector of Factories in Tamil Nadu stated that not more than 10% of workers in the new factories were actually permanent workers. In fact, there has been an increase in the rate of employment in the organized sector in the post-2005 period without any changes to the legislative governance of labour markets. It is in this context that Goldar and Ghosh make an interesting point about the anticipated benefits of employment generation due to labour reforms.7 Given such flexibility of labour governance already achieved, new formal changes to labour laws may not actually lead to an increase in employment as reformers expect assuming, of course, that labour laws actually curtail employment generation.

Even the provisions of the ID Act that supposedly make shedding of labour cumbersome for firms employing more than 100 workers have been diluted by an amendment that redefines the ambit of retrenchment. According to this amendment, termination of services due to non-renewal of contract does not constitute retrenchment. This flexibility encourages firms to resort to fixed term contracts that allow them the flexibility of not renewing contracts if the firms want to shed labour.8 Unlike contract workers, such workers are employed directly by the parent firm. Another major shift on the ground has been in judicial responses to industrial disputes. There is at present a clear move away from a pro-labour stance that was more common in the 1970s and 1980s. Further, the demand for reduced inspections and the set of reforms unveiled comes at a time when the overall inspection rate is reportedly at an all time low.


The argument for labour reforms in terms of increasing employment too, however, does not bear empirical scrutiny. The then Institute of Applied Manpower Research (now renamed as National Institute of Labour Economics Research and Development) commissioned a study to look into factors driving labour absorption in the non-agricultural sector in three states – West Bengal, Uttar Pradesh and Tamil Nadu. The starting point of the study was that employment absorption was lower in Tamil Nadu compared to the other two states. It was expected that the range of social security schemes in the state have led to an increase in the reserve price of labour. The resultant higher cost of labour may have led firms operating in Tamil Nadu to opt for more capital intensive techniques compared to states like UP where wage costs were lower.

Involving a detailed survey of 378 firms, drawn mostly from within the manufacturing sector and to a limited extent from construction and trade, the study revealed that labour costs were not the primary reason for use of capital intensive technologies. Focus group discussions across key segments of the manufacturing sector revealed that the manufacturing sector in the state (TN) was more advanced compared to the other two states, with a higher export market orientation and production for higher end domestic markets where quality standards were higher requiring them to adopt such capital intensive methods of production. In fact, looking at their labour absorption over the previous decade, it was found that on average there was a greater demand for managerial and professional workers vis-a-vis unskilled or semi-skilled workers across small, medium and large firms. According to industry representatives, this trend is in tune with global norms in manufacturing and not quite driven by local factors.


The missing middle argument too has been questioned. To begin with, this pattern is not unique to India and has been observed in several other low income industrializing countries. Scholars attribute other factors such as barriers to access capital by small firms as impediments to expand into the mid-sized segment. People have also correlated the dualistic structure of demand to the dualistic structure of production. More interestingly, in a recent paper in the Journal of Economic Perspectives, a comparative study of structure of the manufacturing sector in India, Indonesia and Mexico reveals that the bimodal distribution hypothesis actually does not hold good. The authors demonstrate that the size distribution of firms in all these countries is very much in line with trends in manufacturing sector development elsewhere.9 Another interesting piece of evidence comes from the distribution of small and tiny firms. A bulk of the firms in India are own account enterprises or enterprises that employ less than six workers; 90% of the firms in fact employ less than five workers. Since the labour laws kick in only when firms employ more than nine workers, it is evident that the inability or unwillingness of the firms to expand is not due to fear of having to comply with labour regulations.


Apart from its shaky empirical premises, the demand for labour reforms is also intellectually limiting. Though not explicitly stated, an underlying assumption behind the argument for labour market deregulation is that Indian labour laws are in a sense, ahead of time. Indian industrial development lags behind global frontiers whereas labour and environmental standards that its laws seek to maintain are comparable to those in the advanced capitalist economies. Labour laws in such countries were an outcome of a much longer history of industrial development and workers’ struggle and co-evolved unlike the Indian case. What this argument fails to consider is that such an imposition of standards may in fact open up new possibilities and allow for a non-teleological approach to industrial development. Just as the fear of the drying up of non-renewable energy resources is pushing countries like Japan and Germany into exploring new energy resources to sustain their economies, such standards create an impetus to imagine the organization of manufacturing production in ways outside the ‘catching up’ paradigm that seems to drive policy making.

It is also implicitly assumed that the driving factors under conditions of globalization are product market changes to which firms need to respond, and at present, this is not happening because of possible rigidities in labour market governance. Once again, it is important to question this privileging of product markets as the prime movers. It is for instance, possible to envisage a primacy to labour market institutions and thus encouraging other variables to adjust in response. The success of Indian software services in the global market provides an example of how this is possible. Somewhere in the early 2000s, Indian software firms were confronted with the problem of a tight labour market leading to a high growth of wages in the sector on the one hand and high rates of labour attrition on the other, undermining the investments that firms made in training labour. In response, the firms embarked on a strategy of utilizing their human capital resources to move into more value adding segments of the services market.10


The labour market pressure in fact enabled the firms to move into newer segments of the product market. Labour laws may therefore prevent firms from competing merely on the basis of low wage costs and hence taking the ‘low road’ to competing in global markets. Such a path may lead to a process of ‘immiserizing’ growth, with increase in output not matched by adequate returns to labour or capital due to severe competition in such segments.

Outside the domain of wage labour, there is a large share of the Indian workforce that is self-employed. In fact, in 2009/10, 50.58% of all workers were self-employed with women accounting for a larger share of this self-employed workforce than men. This constituency of labour is larger than any other, with casual workers accounting for the next largest share (32.79%). The regularly employed account for only 16.63% of the total workforce. If labour reforms are likely to benefit workers in the informal economy, it is only fair that voices from this segment are duly recognized. What is also often not adequately appreciated is the fact that in India the issue is of the underemployed, i.e., the working poor rather than that of the unemployed. About one-fifth of India’s workforce earns an income that is insufficient to move above the poverty line. Labour law reforms are therefore clearly necessary.


The National Commission for Enterprises in the Unorganized Sector (NCEUS), in its several reports, has clearly commented on the need for reform stating that there are too many laws for the small organized segment of the workforce, even as the vast majority labours under conditions that are hardly governed by state regulation. Demand for labour reforms has also come from sections of trade unions. However, as the set of reforms introduced by the current government in August last year shows, suggestions made by the trade unions have been generally overlooked.11 The need for a more democratic approach to labour law reform that takes into account the interests of various sections of informal labour cannot, therefore, be emphasized enough.



1. K.R. Shyam Sundar, ‘Labour Flexibility Debate in India: A Comprehensive Review and Some Suggestions’, Economic and Political Weekly 40(22-23), May 2005, pp. 2274-2285.

2. R. Jenkins, ‘Labour Policy and the Second Generation of Economic Reform in India’, India Review 3(4), 2004, pp. 333-363.

3. A. Sood, P. Nath, and S. Ghosh, ‘Deregulating Capital, Regulating Labour: The Dynamics in the Manufacturing Sector in India’, Economic and Political Weekly 49(26-27), 2014, pp: 58-68.

4. Satyaki Roy, Towards Employment Augmenting Manufacturing Growth. ISID Working Paper No. 168, Institute for Studies in Industrial Development, New Delhi, 2014.

5. T.S. Papola, Role of Labour Regulation and Reforms in India: Country Case Study on Labour Market Segmentation. Employment Sector Working Paper No. 147, International Labour Organization, Geneva, 2013.

6. Ibid., p. 9.

7. B.N. Goldar and Maitri Ghosh, Employment Growth in India’s Oganized Manufacturing: Trends and Determinants. Paper presented at the International Conference on Achieving Accelerated Manufacturing Growth: The Promise and Challenges, 2-3 January 2015, organized by the Madras Institute of Development Studies, Chennai.

8. A. Sood, P. Nath, and S. Ghosh, 2014, op. cit.

9. Hsieh Chang-Tai and B.A Olken, ‘The Missing "Missing Middle",’ Journal of Economic Perspectives 28(3), 2014, pp. 89-108.

10. S.S. Athreye, ‘Human Capital, Labour Scarcity and Development of the Software Services Sector’, in Saith and Vijayabaskar (eds.), ICTs and Indian Economic Development: Economy, Work, Regulation. Sage Publications, New Delhi, 2005, pp 154-74.

11. labour-under-attack/article6540729.ece downloaded on 3 March 2015.