by Vivek Kaul
The Economic Survey of 2015-2016 discussed this problem in great detail by comparing it to the Chakravyuha episode from the Mahabharata. The second chapter of the Survey of 2015-2016 makes a very interesting point: “The Chakravyuha legend from the Mahabharata describes the ability to enter but not exit, with seriously adverse consequences. It is a metaphor for the workings of the Indian economy in the 21st century.”
What is meant here is that Indian companies continue to operate, irrespective of the fact of whether they make money or not. In a free market, as firms innovate and grow, they end up pushing out other firms, which then shut down. But that doesn’t seem to be happening in India.
As the Survey points out: “In principle, productive and innovative firms should expand and grow, forcing out the unproductive ones. So surviving firms should be much larger than new ones…. In the US, the average 40-year-old plant is 8 times larger (in terms of employment) than a new one. Established Mexican firms are twice as large as new firms. But in 2010 India, the average 40-year-old plant was only 1.5 times larger than a new one.”
If the factory size continues to remain small, the number of people an average factory employs will also continue to remain low. This is something that comes out very well through the Annual Survey of Industries (2013-2014). Take a look at Figure 7.1.
Figure 7.1: Comparison of factories according to the size of their workforce.
Source: Annual Survey of Industries (2013-2014).
As can be seen from Figure 7.1, the maximum number of factories employ less than 15 people, and there are barely any factories in operation which employ more than 1,000 people. This shows us the sad state of the Indian manufacturing sector, given that “there are not enough big firms and too many firms that are unable to grow, the latter suggesting that there are problems of exit”.375
What this basically means is that firms which should be shut down are not shutting down due to various reasons, which include the Industrial Disputes Act. Hence, there is an exit problem, a situation that is best expressed by the song Hotel California, sung by The Eagles: “You can check out any time you like / But you can never leave.”
As the Survey points out: “India, unlike many countries, seems to have a disproportionately large share of inefficient firms with very low productivity and with little exit.” Also, in a capital-scarce country like India, misallocation of capital by keeping loss-incurring companies running is not quite the best thing to do. But that is precisely what Big Government ends up doing.
Furthermore, there is Section 25G of the Industrial Disputes Act, which needs to be discussed in slight detail. This section deals with the retrenchment of employees and clearly states that “in the absence of any agreement between the employer and the workman in this behalf, the employer shall ordinarily retrench the workman who was the last person to be employed in that category, unless, for reasons to be recorded, the employer retrenches any other workman”.
This basically means that when it comes to retrenchment, the last in-first out principle needs to be followed, i.e., the worker who has joined most recently needs to be fired first and seniority needs to be respected. This sort of labour law is also unique to India.
So the question is: What can be done about this? The state of Rajasthan introduced some labour law reforms in 2015. When it comes to Chapter V B of the Industrial Disputes Act, the threshold for the government permission to lay off or retrench workers or close down an industrial unit has been increased to 300 workers. At the same time, the threshold figures of the Factories Act have been respectively increased to 20 and 40 workers from the current 10 and 20. With Presidential Assent being granted, these changes have now superseded any constraints that may have been imposed by the central government labour laws.376
Furthermore, this move of the Rajasthan government has received a lot of good publicity. Analysts have said that other states should look to do the same. An impression has been created that Rajasthan is the first state to increase the cut-off, to 300 workers, for government permission for closure, retrenchment or lay-offs. Nevertheless, this is incorrect. The erstwhile Andhra Pradesh increased the requirement to 300 workers in 2006, a whole decade ago.377
Also, when it comes to the number of factories operating in a state, which is a good representation of how industrialised a state is, Rajasthan is pretty low in the hierarchy.
Unless such changes are brought in by the state governments of industrialised states like Tamil Nadu, Maharashtra and Gujarat, labour law reform in India will just remain a pipe-dream. If any of these states attempts significant labour law reforms, there are bound to be huge protests from the trade unions. It will then become clear if the governments in these states have the necessary resolve required to push through labour reforms. Interestingly, Gujarat and Madhya Pradesh have said that they plan to make changes to a large number of labour laws in order to make their states more investor friendly.378
In fact, the government of Gujarat has introduced some labour reforms, but they are more along the lines of jugaad, or trying to get around the current set of labour laws, rather than genuine reform.
In 2004, Gujarat passed the Gujarat Industrial Disputes (Amendment) Act and the Gujarat Special Economic Zone Act. These two Acts essentially ensured that Chapter V B of the Industrial Disputes Act was replaced by a more liberal regime. For companies operating inside a Special Economic Zone (SEZ; to be discussed in the next chapter), the government authorisation of retrenchment was replaced by a limited right to compensation for workers who had worked for a year or more.379
This, along with improvements in infrastructure (power, water and roads), pushed up the industrial growth rate in the state, which between 2001 and 2004 had stood at 3.95 per cent per year. This jumped to 12.65 per cent per year between 2005 and 2009.380 While this liberal regime did work, it was available only to those firms operating inside SEZs. It didn’t do anything for firms continuing to operate outside the SEZs, which wasn’t fair to them.
Given that we are discussing solutions, there needs to be some flexibility in reading Section 25G, the seniority clause which basically mandates that the most recently hired hand needs to be fired first instead of taking into account which worker is more required in order to keep the business going.
Another factor that could possibly be worked on in order to make a retrenchment palatable for workers is the compensation. Currently, the compensation offered is 15 days of pay for each year of employment. In China and South Korea, the compensation offered is 30 days.381 Something similar can be done in the Indian case as well, so as to effectively double worker compensation in order to ensure that they don’t stand in the way of a lay-off or retrenchment or the closure of an unviable firm. Also, it is important to not overdo this. The Rajasthan government has raised the retrenchment compensation to 90 days for every year of service put in by the worker.382 This obviously makes it very expensive for companies to retrench workers.
****
When it comes to labour laws, the economies of scale really don’t kick in, as we saw in the case of the Factories Act earlier in the chapter. As Bhagwati and Panagariya write: “The costs due to labour legislations rise progressively in discrete steps at seven, ten, twenty, fifty and 100 workers. As the firm size rises from six regular workers towards 100, at no point between the two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra costs of satisfying these laws.”383
In fact, Bhagwati and Panagariya recount an interesting story they were told by the economist Ajay Shah. A few years ago, Shah asked a leading Indian industrialist a very basic question. This industrialist was already making yarn and cloth. So why was he not in the business of garment manufacturing? The industrialist explained that garment manufacturing was a low-margin business and that it would be worth the trouble only if he operated on the scale of one lakh workers. But given India’s restrictive labour laws, that would not be practical.384
In fact, this is precisely the reason foreig
n investors have stayed away from setting up mass-manufacturing bases in India. They don’t like the idea of not being able to retrench workers, depending on supply and demand. Also, what scares them away is the fact that no guidelines or principles have been laid down on how the government decides on whether to allow a firm to retrench workers or not.385
Furthermore, in a globalised world, both foreign as well as Indian companies operating in India need to be competitive as well as fleetfooted in managing their costs. This means being able to hire and re-hire workers according to the demand at any given point of time. In the case of garment manufacturing, a lot of demand is basically export demand. This means that the demand tends to pick up sometime before Christmas and New Year’s, and then falls. In an ideal scenario, this would mean hiring workers just a few months before Christmas and then letting them go after the garments have been made and shipped. But that is not possible, given that permission from the government is needed. This essentially means that garment companies operating in India cannot respond to fluctuations in demand.386
As the 11th Five-Year Plan (2007-2012) points out in this context: “However, Chapter V B of the ID Act, 1947, does create a psychological block in entrepreneurs against establishing new enterprises with a large workforce and impede [the] attainment of economies of scale. As a result, firms prefer to set up enterprises with a smaller permanent workforce, and these enterprises are unable to cope with largesize[d] orders from retail market chains, in garments and footwear, for instance.”
The Plan also explains why India is behind China when it comes to low-skill manufacturing activities like apparel and textiles:
The main reason for India to be well behind China in textiles and clothing is the absence of economies of scale in the manufacturing enterprises in the country. While many units in China have tens of thousands of workers, the industrial units in India are discouraged by the requirements of Chapter V B of the Industrial Disputes Act… from employing more than 100 workers. The result is that the industry is fragmented and is unable to respond to the large volumes of orders that are placed by the retail chains in the industrial economies.
In fact, a good comparison here is provided by the Indian information technology industry. After the dotcom and telecom bubbles burst in 2000-2001, many Indian companies postponed the joining of engineers they had recruited. This was done primarily because, with the bursting of the technology bubble, the demand that these companies had anticipated from international companies slackened. In fact, in some cases, the engineers they had recruited joined the company after a waiting period of more than a year.
In May 2016, L&T Infotech withdrew job offers to nearly 1,500 engineers. The ecommerce major Flipkart postponed the date of joining of MBAs it had recruited from the IIMs from June 2016 to December 2016. There are examples of several Indian airlines firing their employees during periods of low demand.
While this is not a direct comparison with Indian manufacturing, the point is that there are times when companies need to adjust their number of employees depending on the demand for their products or services. This is essential for their survival. Of course, there are cases when companies make a mistake in projecting their demand and then need to course-correct. So, lower-level employees tend to get fired for no fault of theirs.
While Indian companies not operating in the manufacturing space have the flexibility to retrench their employees, those operating in the manufacturing sector don’t. This has led to a situation wherein the bulk of Indian firms in the manufacturing sector continue to remain small.
This is a very important point for the Make in India programme. If we want foreign firms to make products in the country rather than import them from China and then sell them in India, there will have to be some flexibility adopted regarding Chapter V B of the Industrial Disputes Act. Firms will have to be allowed to hire, fire and re-hire employees depending on their demand scenario. By not allowing firms to do this, the current labour laws essentially work in favour of those who already have permanent jobs and not in favour of the overall labour pool, as the case should be.
Furthermore, if India wants foreign companies to Make in India, it needs to be a part of the global supply chains of multinational companies. And it can’t be a part of the global supply chains unless it is a lot more flexible on its hiring and firing policies. (As we saw in the previous chapter, global supply chains are what drive a good proportion of exports in this day and age.)
Also, there is a rather fundamental question that Chapter V B of the Industrial Disputes Act raises. As Anwarul Hoda and Durgesh K Rai ask in a research paper titled ‘Labour Regulations and Growth of Manufacturing and Employment in India: Balancing Protection and Flexibility’: “When entry into manufacturing activity does not require permission, there is no justification for exit requiring [the] government’s consent.”387 Indeed, that is a very valid point.
Other than Chapter V B, another major cause for concern in the Industrial Disputes Act is Section 9A. As per this section, if the job content or the nature of work of an employee or a group of employees needs to be changed, they need to be given a 21-day notice. In practice, the consent of the worker is also required. In an era of machine-driven manufacturing and new technologies, this becomes a serious impediment to a company looking to introduce a new technology. It may want to redeploy some workers, but it’s possible that the workers may not give their consent.388
To conclude this section, it is worth quoting the economist TN Srinivasan, who, in a 2003 speech, said:389
The cost of hiring and firing of workers by firms covered by [the] labour laws is high. It is virtually impossible for uncompetitive and loss-making [i.e., loss-incurring] enterprises above a certain size to close down without getting government permission and going through costly delays. The sorry tale of the Board for Industrial and Financial Restructuring, to which such enterprises have been referred, is well known. The Second Labour Commission, in its report, has documented that our labour laws… [are] a major contributory cause of our abject failure to increase by very much the share of our labour force employed in manufacturing.
Until now, we have discussed the Factories Act and the Industrial Disputes Act. Now we shall discuss the Contract Labour (Regulation and Abolition) Act, 1970, and the Trade Unions Act, 1926.
****
The number of people working in the organised manufacturing sector had stood at around six to seven million (60 to 70 lakh) for the period of 10 years up to 1991, when the economic reforms were initiated. The number of people working in organised manufacturing grew at a very slow pace after that. In fact, in 1998-1999, the number actually started to decline. In 2001-2002, the number of people working in organised manufacturing had stood at 5.43 million (54.3 lakh). However, things picked up after 2001-2002, and by 2011-2012, the number of people working in organised manufacturing had more than doubled, to 12.88 million (1.29 crore).390
So what brought about this jump? Rather ironically, the Contract Labour (Regulation and Abolition) Act of 1970 and a few developments around it.
In the 1960s, companies started to use contract labour in order to bring down their labour costs by paying lower salaries. Also, contract workers were denied social security benefits. In order to clamp down on this trend, the government introduced the Contract Labour Act in 1970.391 As is the case with other labour laws, the law was adopted by state governments as well. The idea was to get companies to recruit more permanent workers.
The Act applies to every firm or contractor who employs 20 or more workers on any given day in the past one year. The Act basically divides work between core activities and non-core activities of a firm, and says that the contract workers should be employed only for the non-core activities of the firm. Furthermore, the contract workers employed in the non-core activities need to be paid the same compensation as the permanent employees of the firm who are carrying out similar work.
The contractors need to get a licence in order to operate, and the fi
rms need to be registered as principal employers with the appropriate authorities. The Act also makes the firm employing the contract workers liable for prosecution if the contractor through which the contract workers have been employed defaults on wages, health insurance, provident fund, bonuses, etc.392 In case the contractor fails to pay the wages in part or in full, the principal employer is liable to pay the same.393
This is something that needs to change. Given that the contractor needs to get a licence in order to become a labour contractor, he should be treated as the principal employer. This is likely to make the contractors more responsible in the way they treat their contract workers.
Even though contract workers are an important part of Indian factories, the thinking that contract workers should not be allowed to work in factories has historically been a part of the Indian attitude. The Bombay Textiles Labour Enquiry Committee (1938) was of the view that “if the management of the mills” did not take on the “responsibility for such labour”, there was a good chance “of its being sweated and exploited by the contractor”. It didn’t stop at this and, in fact, recommended the abolition of the contract system of engaging labour as soon as possible and that “workers for every department in a mill should be recruited and paid directly by the management”.394
The Bihar Labour Enquiry Committee of 1941 went along the lines of the Bombay Textiles Labour Enquiry Committee. It condemned the recruitment of workers through contractors because it felt that “the contractors ordinarily lack a sense of moral obligation towards labour, which the employers or the managers are expected to have, and, therefore, do not often hesitate to exploit the helpless position of the labour in their charge”.395