Untangling the debate on labor law: what does the evidence really say? – analysis
The coronavirus-related blockade has put more than 130 million people out of work. Many of them are migrants who return to their home states. Over the past few weeks, some states, particularly traditional migrant states, have issued ordinances to significantly relax or suspend labor laws. These changes aim to remove potential impediments to job creation in order to absorb the unemployed, especially returning migrants, and / or attract foreign direct investment. There are several issues related to the constitutionality of these ordinances, but that is for lawyers and legal scholars to debate. As economists, our research, based on readings of the available evidence, highlights the costs and benefits of these modifications.
The changes adopted are a mixed bag. Madhya Pradesh, among other measures, has limited the role of inspectors and has removed many provisions of the Factories Act (the law governing health and safety in manufacturing companies). Gujarat has retained the industrial safety regulations and the Minimum Wage Law, but eliminated all other laws for new industrial establishments. Uttar Pradesh has eliminated all but a few laws for a period of three years (pending approval by the state legislature and the President of India for the Concurrent List laws). Several states have modified daily work hours from eight to 12 (some with and others without overtime pay). Assam’s approach is different. He has legalized fixed-term employment (previously, he needed a license under the Employment Contract Law) and stipulated equal social security benefits for fixed-term workers as permanent workers in the same unit.
These changes can be usefully distinguished into two types. One, those that aim to reduce the labor costs of companies by reducing workers’ benefits, such as minimum wages, health and safety regulations, payments of social security funds and bonus payments, and two, those that aim to increase the business flexibility by reducing firing costs, such as employment protection legislation. The conceptual implications and empirical evidence for each type are different.
In a basic supply and demand framework, the reduction of the labor costs of the companies should increase the labor demand. But when you consider information asymmetries or market power, this prediction fails. When worker effort is difficult to observe, employers can provide higher-than-market wages to increase productivity and minimize turnover (the efficiency wage theory). In markets where employers have wage-setting power, most low-wage labor markets, the introduction of a minimum wage does not necessarily lead to adverse employment effects, as evidenced by Arindrajit Dube and his co-authors, and by in fact, it can even generate employment gains, as evidenced by Vidhya Soundararajan, co-author of this article.
Additional complications arise as the laws on the books are often not enforced. Urmila Chatterjee and Ravi Kanbur find that the Factory Law is characterized by widespread non-compliance. Despite noncompliance, these laws still seem to impose costs on some companies: In a recent document, Amrit Amirapu and Michael Gechter find that the de facto costs imposed by type 1 regulations on companies can be very high (up to 40% of labor costs), but only in states with high levels of corruption or those that have not reformed their inspection rules. This implies that if there are corrupt inspectors, labor laws are complex and opaque enough to provide them with leverage to extract bribes. However, they do not generate full compliance, leaving workers unprotected. This could explain why, according to the 2014 World Bank Business Survey, only 11% of Indian companies (medium and large) reported that labor regulations are a “major constraint”, while 36% thought that the Corruption is an “important restriction”.
The solution, then, is not to eliminate these benefits entirely, but to consolidate and simplify them, so that they can be effectively implemented with less room for extortion. Indeed, Parliament has already begun to deliberate on the matter, and it should be allowed to proceed carefully, albeit expeditiously. There is no justification for the complete suspension of such laws, leaving workers completely unprotected and companies only marginally better.
Turning now to Type 2 “reforms”: they refer to Employment Protection Legislation (EPL), which restricts hiring and firing. The relevant legislation in India is the Industrial Disputes Act (IDA) of 1957. Most aspects of this act are fairly standard. For example, Section V-A of the law stipulates that a dismissed or fired worker must be adequately compensated, which is similar to the policies in many other countries, including Germany, France and the United Kingdom. It is Chapter V-B of the law that prohibits companies with 100 or more permanent workers from firing even a single worker without the consent of the government, and this stands out for its rigor (at least on paper). It is possible that this part of IDA is intended to somehow compensate for the lack of social insurance mechanisms (unemployment benefits / public health insurance) in India. The problem with using EPL as social security is twofold. First, India’s EPL is limited to medium and large formal companies, so that only a fraction of the non-farm workforce is covered. Second, it could distort the efficient functioning of labor markets by discouraging companies from hiring permanent workers.
Empirical evidence on whether India’s PLA has reduced employment or output in India is inconclusive, and the debate started by Timothy Besley and Robin Burgess has been refuted by Aditya Bhattacharjea (in 2006, 2009, and 2019) and others. . However, there is clearer evidence from other countries that the strict EPL can reduce employment, business productivity, and investment (employment and productivity in the US by David Autor and co-authors, and Italy by Federico Cingano and co-authors). There is also evidence from India that EPL encouraged the use of contract work (as shown by Ritam Chaurey), whose share grew from 15% to 34% in Indian manufacturing between 1999 and 2015. This phenomenon may have reduced the incentives to invest in human capital and reduced productivity, in addition to undermining the bargaining power of unions, as evidenced by Nancy Chau and her co-authors.
Overall, international evidence suggests that type 2 laws do limit job creation, investment, and productivity. In India, although the conclusive evidence is elusive, at least Chapter V-B, the strictest part of IDA, could be removed and replaced by a more effective and expansive social insurance mechanism (such as unemployment insurance or UBI). These measures will provide companies with greater flexibility without undermining the well-being of workers.
How, then, do we understand these “reforms” in light of the previous evidence and the demands of the moment? Given the tragic situation of migrant workers and massive general unemployment, the primary concern should be to save lives immediately through a combination of cash and in-kind transfers. The next concern should be to improve livelihoods, doing what is necessary to facilitate rehiring.
Given the high human costs of unemployment on the observed scale, states understandably want to urgently remove impediments to hiring, even if it means tipping the balance of power toward business. However, our reading of the academic literature suggests that the full suspension of type 1 laws is unlikely to improve worker welfare or substantially increase employment and should therefore be restored immediately. Eliminating type 2 labor laws would improve welfare by increasing employment only if laid-off and laid-off workers have adequate social security. Providing the latter should be the urgent task of the moment.
Amrit Amirapu is a tenured professor at the University of Kent, and Vidhya Soundararajan is an assistant professor at the Indian Institute of Management in Bangalore.
The opinions expressed are personal.