New wine in an old bottle

Written by Poonam Gupta | Updated: Feb 28 2013, 06:21am hrs
This years Economic Survey has been prepared under a very grim economic scenario. It is also the first survey steered by the CEA, Raghuram Rajan, and quite plausibly might just be the last one under the current government. There is justifiable curiosity among the economists to see whether there are any definite imprints of Rajan and his team on the survey. I guess they will not have to look hard and they would not be disappointed either.

While a large chunk of the survey is the usual narrative on the data, trends, and prospects of the economy, it includes an interesting new chapter, titled Seizing the Demographic Dividend. The chapter provides a thorough and instructive discussion on the sectoral transformation of the Indian economy, and highlights the peculiarities of this process in the Indian context. In order to do so, it draws liberally on the cutting edge research done in India and elsewhere, and discusses the key reform initiatives to address the peculiarities of the growth process.

The survey reminds that the agriculture sector in India is shedding labour way too slowly, as a result of which a large share of the labour force remains trapped in low-productive agricultural activities. The industry sector is in its own woeful state of affairs, wherein the share of industry in GDP has remained stagnant for almost two decades. Comparing the Indian experience with that of China, Indonesia and South Korea, at similar stages of their respective reform trajectories, shows that the size of the industrial sector in India is smaller than that of comparable countries at similar stages of reforms. Despite being a labour abundant country, the pattern of production within industry is skewed towards capital and skilled labour intensive activities. Firms shy away from expanding their size and entering the formal sector. Hence, within industry as well a large fraction of labour is employed in the unorganised sector, working under the conditions of low productivity, drawing low wages and affording very little social protection. On the other hand, the small per cent of the privileged workers, who are engaged in the organised sector, are protected through a myriad of labour laws. While the service sector has stepped in to fill the slack a bit, it is also wobbled by an inadequate availability of educated and skilled labour, and by regulatory burden.

In this milieu, India is experiencing even greater additions to its labour force due to an increase in the share of its working age populationthe so called demographic dividend. The survey emphasises that a key challenge facing India is to translate the favourable demographics into a dividend and not a curse. Overcoming the challenge would entail a faster transition of labour out of agriculture into productive industrial and service activities, and a transition from the unorganised sector into the organised sector. But how could all this be done The chapter recommends an entire ecosystem of reforms. It highlights the need to undertake labour reforms, as well as land reforms; significantly improve the business environment; improve access of the firms, especially of micro, small and medium firms, to finance; improve the infrastructure; and ensure a faster and efficient process for the firms to exit; improving educational outcomes and improving the skill content in labour.

The novelty of the Survey does not lie in these recommendations per se. Indeed, scores of researchers over the years, based on scientific evidence, have made similar recommendations. The novelty lies in the fact that it has shown the courage to discuss these constraints to growth and productive employment. It has also discussed the remedies. Take labour market regulations, for example. In no other surveys in the past, and I checked the surveys in more than ten consecutive years, did I find any serious discussion of the need to reform the labour laws.

The evidence in academic journals has consistently shown that the existing labour regulations in India are not conducive to growth or employment, and indeed the growth in labour-intensive industries has been faster in states with flexible labour laws as compared to the states with inflexible labour laws. As if taking a cue from this literature, the survey recommends that as a first step, the states could be granted more flexibility in the way they formulate and implement their labour laws. Since labour is in the concurrent list, both states and the Centre currently have jurisdiction on it. Hence the greater flexibility to the states ought to be afforded only without coming into conflict with the central statutes. It hopes that, as best practices evolve across states and the employment effects of relaxed labour laws are realised, the theoretical debates would be settled much more decisively. It also projects that the practices would be emulated widely.

To handle opposition from the incumbent workers, the Survey offers a practical solution: while the existing permanent workers could be grandfathered, and allowed to continue with their existing set of privileges till retirement; the new workers could be hired under more flexible arrangements. The latter would, however, be provided adequate protection including severance pay, unemployment insurance, and the right to reverse unfair dismissal through appeal.

Interestingly, the Survey recognises that in India reforms are typically implemented only after they have been subject to a lot of debate and after some sort of a political consensus is reached on them. Hence, it is imperative that with respect to some of the crucial reforms, such as the ones related to the labour market, the groundwork and consensus building should be started soon.

For faster poverty reduction and to raise the standards of living, India needs both industry and services to grow faster. Given Indias vast population and the masses of unskilled, uneducated people in the work force, it is important that any growth path is intensive in its use of labour and particularly unskilled labour. In this direction, reforming labor laws would surely be pro-growth, pro-employment and pro-poor.

Poonam Gupta is the RBI chair professor at the National Institute of Public Finance and Policy