A priority of the new government should be to reform labour laws
  • With an extremely high-pitched campaign over the last couple of months behind us, now is the time to get back to the agenda of reforms. On the top of the new regime’s list should be labour laws.

You can also read this article in Hindi- श्रम कानून, जिनमें तत्काल प्रयासों की है आवश्यकता

In many ways, India’s recent economic growth has been impressive, and it has come with a substantial reduction in extreme poverty rates and a simultaneous expansion of the country’s middle class. Consequentially, we now know that India’s growth does have a positive and significant impact on those who are at the bottom of the pyramid and thus, sustaining a high growth rate should be a high priority area for the new government. This would require policy continuity combined with several big-ticket reforms and procedural tweaks to improve India’s ‘Ease of Doing Business’ and attract greater investments.


While there’s a fairly long list of pending reforms since the last three decades, the most urgent reforms must be in the area of India’s labour laws. This is because despite the benefits of India’s growth, a challenging feature has been that this growth came with a pick-up in the services sector rather than in the manufacturing sector. A likely consequence of this was the lack of adequate non-farm low-skilled jobs to relocate surplus labour from the agricultural sector to the manufacturing sector.

A major reason behind this situation could be India’s rigid labour laws, especially the Industrial Disputes Act. Under this act, any firm that has more than 100 employees requires prior government permission to lay off any worker, and thus, it is a characteristic feature of India’s command and control economic model from the Nerhuvian era. In fact, India has around 200 different labour laws that aim at serving the ‘interests’ of workers in the economy (at least 40 of them are under the central government).

Share of sectors in real Gross Value Added (GVA) at factor cost Share of sectors in real Gross Value Added (GVA) at factor cost

It is now known that these laws had a negative impact on the formal sector employment growth in the economy and led to more informalisation of the manufacturing activity in the economy. Additionally, these laws can also explain why India’s growth has come primarily from the services sector, which tends to be less labour intensive than compared to the industrial or the agricultural sector. (The share of industry in GVA has been more or less constant while services share has expanded at the expense of the agricultural sector).

Therefore, the same laws that were supposed to protect the interests of workers became discriminatory as while they protected the interests of those who were a part of the formal workforce, those outside of it were required to work in the informal sector without any social security. Despite the growing population and the rising aspirations of people, most governments avoided undertaking labour reforms on a priority basis that would further promote formal employment opportunities.

As a consequence, most industrialists have invested in capital intensive sectors rather than labour intensive sectors in India and thus, there has been limited expansion in employment under the manufacturing sector. The share of employment across the three sectors indicates how agriculture dominates the rural employment scenario while urban areas are dominated by employment in tertiary sector.

Share of Employment of Men for Rural and Urban Areas Share of Employment of Men for Rural and Urban Areas

The previous government did initiate the process as it initiated the work on the recommendation of the second national commission that suggested that labour laws should be grouped into four labour codes, namely, labour codes on wages, on industrial relations, on social security and welfare and on occupation safety. The progress, however, on enacting these laws has been substantially slow as they’re stuck in the parliamentary process or in the consultation stages. Additionally, after the political opposition to land reforms, it is only prudent to expect stiff resistance to any genuine attempt at bringing labour reforms.

However, political opposition can no longer be an excuse to delay the changes in labour code any more as it is necessary for the continuity of the reforms that were undertaken by the previous government which have resulted in more formalisation of the Indian economy.

Further, the draft labour code on industrial relations as suggested retains the need for government permission to lay off workers, while modifying the rule for firms with more than 300 employees (Chapter 10 of the Labour Code on Industrial Relations). While this is an improvement from the current law, however, the law is likely to restrict firms to rapidly expand and take advantage of a high scale of production.

Therefore, it will cause significant distortion in the labour market and further incentivise firms to either set up new firms and distribute their employment or alternatively hire contractual labour (which may also be informal in nature for some manufacturing activities). As is the case, prior permission from the government to lay off workers in an industrial organisation goes against the spirit of private entrepreneurship and it is yet again a feature of the command and control economy.

What could, and rather should be done is that the government does away with the excessive norms that restrict the ability of firms to adjust employment. Alternatively, the government could modify the law and accept the recommendation by Professor Jagadish Bhagwati and Professor Arvind Panagariya that suggests that downsizing in response to changes in demand and technology should be excluded from the definition of retrenchment under Industrial Disputes Act.

We know that there are hiring, firing and training costs. So firms, in general, do not adjust the number of employees during a positive or negative business cycle but they rather adjust the number of hours that an employee works. Simply put, in the real world, there are costs associated with changes in the employment levels and these costs disincentivise firms for firing (or hiring) new employees without the explicit economic need to do so. Therefore, concerns of retrenchment of workers due to change in temporary economic conditions are over-exaggerated and a reduction in employment would only happen if the business is no longer viable.


Additionally, state labour laws are also important as they have a substantial impact on the manufacturing activity within the state and the fresh investments that it receives. This makes it necessary that the central and the state governments work together towards rolling out the much-needed reforms to create a free labour market.

An ideal scenario would be if the central government could bring together all state governments on board and create a unified labour code for the entire country. Despite the intuitive appeal of the idea, it is highly unlikely due to the political considerations in India. But the government could instead engage more proactively with the states and help them draft their own laws that simplify their labour norms.

Simplification of these laws will also be instrumental in bridging the regional divide in manufacturing activity as the heartland (which has a high labour density) can specialise in labour-intensive production activity while the peninsular region can continue to focus on capital intensive manufacturing.

A critical feature would be, however, to push out these reforms early in their tenure as they have been long delayed, and this delay has curtailed the potential of India’s manufacturing sector growth over the last three decades.

With an extremely high-pitched campaign over the last couple of months behind us, now is the time to get back to the agenda of reforms and it would be a good idea to begin with a politically difficult reform area like labour reforms early in tenure. The backlash, if any, would be temporary, politically motivated and insignificant while the benefits are likely to be substantial over the next couple of years.

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