'Labour laws and output growth', The Hindu, 5 June, 2001.

A target rate of growth of nine percent, by comparison with the current six and something, has increasingly entered discussions on the future of the economy. Most prominently, it has found mention in the Budget Speech of Mr. Yashwant Sinha. Subsequently, it has figured in analyses of India’s potential and the factors holding back its attainment. The background to the announcement of an higher target rate of growth for India is the increasing recognition on the eve of the completion of one decade since the initiation of the reforms, that in terms of the rate of growth of output the economy appears to have not been sprung onto a higher trajectory. This of course does not necessarily damn the initiative itself for there is no single overriding criterion by which we may evaluate the reforms. There is, after all, the question of the balance of payments, and it has been not appreciated enough that, literally, every single indicator of India’s external payments position has improved since 1990. Nevertheless, the fact remains that the promise of a faster rate of growth did spike the rhetoric of reforms, and we don’t have one as yet.


            The more prominent among the reformers now argue that India’s `labour laws’ are significant impediment to raising the rate of growth of the economy. Indeed this is part of an argument that the `second generation’ of reforms must address the factor markets, the first generation having addressed the product markets where the possibility of competition has been introduced via the abolition of industrial licensing and the liberalisation of trade. Actually, prohibition of lay-off, retrenchment and closure, collectively referred to as `labour laws’ has not been with us always. The Industrial Disputes Act (IDA), 1947, which had emerged out of the Trade Disputes Act of 1929, had made a provision for these without providing a procedure to be followed. IDA (Central Rules), 1957 had introduced such a procedure. IDA (Amendment) 1976 introduced prohibition in the form of requiring the employer to first seek the permission of the `appropriate’ government prior to lay-off, retrenchment or closure. In 1984 its ambit was extended to cover industrial establishments with more than 100 workers having till then been confined to establishments with more than 300 workers.

            It is not at all clear as to what precisely may have motivated those responsible for the provisions that appear to prolong the tenure of the already employed under the Industrial Disputes Act. Whatever it may have been, though, it cannot be the level of employment, leave alone of output for, in a market economy, the demand for labour is ‘derived’. Since labour is hired to produce, the demand for labour is derivative of the demand for output. If labour laws, in the form of clauses against closure are unable to help create employment might they possibly damage otherwise good prospects for it? They may, in two ways. First, where the substitution of capital for labour is possible, for fear of being stuck with excess labour firms may well choke-off any rise in employment that would naturally accompany rising output. Such `jobless growth’ actually appears to have occurred in the 1980s and 1990s when official statistics reveal slow growth of employment despite a considerable step-up in the rate of growth of output. Of course, noting such an episode is far from having established that this is due to the existence of labour laws. Note that even when such causality is established the outcome does not necessarily involve loss of output. Recall that we have here allowed for the possibility that labour may be substituted by capital. In fact, now final output may be higher, for the substitution of labour by capital involves a larger order for equipment. Where a substitution of labour by capital is infeasible any disincentive due to restrictive labour laws would depress not only the hiring of labour but also the level of investment. The behaviour of investment would then be one way of divining the impact of labour laws on the economy.

            This can be better seen through an example. Shall we say that wary of the `no-retrenchment’ stance of the government there our intrepid capitalist moves lock-stock-and barrel away from the intrusive rulers of Lamnad to neighbouring Limatnad, a laissez-faire paradise. This would mean a permanently lower output in Lamnad and a permanently higher one in Limatnad. However, this transfer does not by itself affect the rates of growth of the industries that remain in the former state which will be determined by factors such as the growth of demand and the growth of infrastructure, to name only two. The example here considers a spatial transfer. However, the writ of the Industrial Disputes Act is economy-wide and thus the transfer that we need to consider is a temporal one. That is, where labour laws act as a disincentive investment is permanently postponed, once again affecting the level of output. Yet the parable of the two states enables us to see clearly that factors other than labour laws would have to be the ones at work when it comes to accounting for the differential, if any, in the rate of growth of output over time.

            In the example that we have considered it is the prospect of a future decline in demand for labour that prompts the migration of capital, over space or over time, thus affecting the level of output but not its rate of growth. We can, however, construct an example where barriers to exit not only affect growth of output but actually do so in the context of an increase in the demand for labour. First, recall that a large part of economic growth occurs in the form of the emergence of new products on the technological frontier. Then, back to our two states, assume that the demand for such a new product is large enough to occupy the entire labour force of Lamnad and that this incipient demand grows faster than its current rate of growth of output. Now, were all producers in Lamnad to switch to producing this product its economy would grow at a faster rate than ever before. However, closure laws might prevent such a switchover, for companies must first close to start all over again! Output and employment would now grow at a permanently slower pace than the potential one offered by the emergence of the new product.

            The `proof of the pudding’, so to speak, cannot, however, lie in these examples when what we are interested in is whether labour laws have in fact been a fetter on the rate of growth of the Indian economy. On the other hand, we can get some handle on this issue by studying output growth in Indian industry over time and in relation to the economies of East Asia from the experience of which the nine percent goal has been borrowed. It is now widely recognised that the truly impressive East Asian growth was accompanied by a steadily rising growth of investment. Five countries there figure among the only fifteen internationally to have raised investment to as high as 30 percent of their total output. For perspective, India currently has an investment-to-output ratio of about 24 percent while the figure for Korea is around 37 percent. Since 1950, in India, the level of investment in relation to output increased slowly but steadily till the 1980s during which decade the ratio displayed a marked increase, only to stagnate in the 1990s. This by itself goes some distance in both accounting for the record of growth since 1991 and for enabling us to comprehend the likely role of labour laws. Ad seriatim, the credit for sloughing-off in the 1980s the slow growth of the preceding three decades goes to a shift in the investment rate, and the stagnation of growth into the 1990s is entirely due to the inability of the reforms thus far to bring about its further increase.

The significant increase in the rate of growth of investment in the 1980s does point to the feature that the labour laws, enshrined since the 1940s, do not necessarily fetter output growth when supply and demand factors are favourable. Nevertheless, extant restrictions on the exit of firms must go. The labour laws that form the basis of these constitute the curious meeting ground of three historically distinct self-serving forces: of a colonial rent-seeking state hostile to native enterprise, of a bureaucratic paternalism that was the fig-leaf termed socialism by its Indian successor, and the desperate attempts by Indira Gandhi to secure personal power during the Emergency by purchasing the support of groups that included a susceptible intelligentsia. India’s workers face some of the most trying conditions in the world. Their due is beyond laws. Among its ingredients are a vibrant economy, enabling interventions in the social sector and, of course, good management. This calls for intelligent and compassionate leadership, both political and corporate, not pious legislation.