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Macro and Micro Evidence: Labour Reforms Do Not Facilitate Growth in the Manufacturing Sector

Written by Navya Jain

MA. Development Studies, Ambedkar University, New Delhi

Disclaimer: Please note that the views expressed below represent the opinions of the article's author. The following does not necessarily represent the views of Law & Order.


If India had followed the footsteps of other developing nations during the 1980s and the 1990s, it would have witnessed a typical growth trajectory of that time period: after achieving an optimal growth rate in the agriculture sector, there would be a declining trend in the GDP share of the sector which would have been compensated by the growth in the industrial sector. However, the decline in the agriculture sector was accompanied by the service sector growth throughout the 1980s and 1990s. Even the liberalization policies introduced in 1991 were focused on pushing growth in the manufacturing sector but failed to make any significant impact. It is usually observed that the growth surge triggered by a flourishing manufacturing sector gives developing nations the scope to expand labour-intensive exports and an opportunity to improve imports as well; but neither has happened in India (Panagariya, 2004). Despite the adoption of liberalization reforms, the manufacturing sector has not contributed substantially either to the GDP or to the employment-share and falls behind the agriculture and the service sector.

The low employment-share could be attributed to the technological developments replacing manpower but the onus of average performance of the industrial sector is often pinned down on the labour regulations in India.

Since Independence, the workers in India were not treated as the resources to be used for achieving developmental goals but they were seen as equal partners in the journey of development (Sharma, 2006). It was considered important to protect the interests of the labourers from exploitation and to ensure job security to them. Such an approach was never considered to be against the capitalists. It was believed that workers who felt secure about their jobs and were given better working conditions with feasible hours and decent wages would be able to generate better efficiency. Such an improved efficiency would cover the additional costs generated from the labour regulations (Papola & Pais, 2007).

According to an analysis by Besley and Burgess, registered manufacturing businesses suffered because of the regulatory labour laws. They argued that trade unions hampered the productivity of the businesses and they proved it by showing that the states with more pro-business policies performed better as opposed to their counterparts. The idea was that pro-business policies such as de-licensing and reduction in tariffs would be able to produce the desired results only if they are supported by the informal institutions in which they operate (Kotwal, Ramaswami, & Wadhwa, 2010). Unlike formal institutions, informal institutions are the external environmental agents such as the culture, traditions, or codes of behaviour of the society (Chakravarty & Bose, 2011). They furthered their argument by saying the growth in the unorganized sector was possible because it was not regulated. The firms respond to the strict labour regulations by resorting to contract or temporary labour which is reflected in the expansion of employment in the unorganized sector. In order to avoid stringent laws, firms shift business units to states with lenient labour laws or adopt new technology, subcontract a part of the business that is labour-intensive to multiple smaller firms. Small businesses restrict expansion to remain outside the purview of the law by not hiring workers formally in order to retain their authority over the business. Thus, the absence of labour regulations provided the firms with an incentive to continue as small enterprises without trying to expand (Sharma, 2006).

It must be noted here that the labour regulations are implemented only in the organized sector employment constituting only 7-10 per cent of the total labour force (Papola & Pais, 2007).

Even though the post-liberalization reforms brought about an increase in productivity, the wages continued to remain stagnant because of the inadequate bargaining power of the employees. Effectively the reforms gave enough leverage to the capitalists for escaping the strict rules (Nagraj, 2004). The Industrial Disputes Act (IDA), 1947, that was enacted for the investigation and settlements of industrial disputes thereby giving the employees some leverage, was actually draconian and its implementation was very poor. There were periods of retrenchments but they were not reported. The government set up the National Renewal Fund to finance the retrenchment of workers in the public sector and this was an indication for the private sector to follow suit and adopt similar practices (Papola & Pais, 2007). Irrespective of the above, it must be reiterated that the impact of changes in IDA resulting in improvement in output cannot provide a proper view of the impact of the labour market on output as IDA covers only a small portion of the workforce (Papola & Pais, 2007).

Considering these facts, this article aims to debunk the view that labour reforms facilitate the growth of the manufacturing sector in India through macroeconomic and microeconomic analyses. The macro-analysis gives a view of the net collective experiences of the economy such as comparison of the employment rates in the formal and informal sector and lack of dependence on the growth rate of the manufacturing sector on the employment rates. Macro evidence also shows that the employment-share of the manufacturing sector remained the same in the 1980s while the first half of the 1990s witnessed a rise, followed by a 13 per cent fall in jobs between 1995-96 and 2001-02 (Sharma, 2006).

It was a period of jobless growth. If the labour laws were taken seriously in the post-liberalization period and were implemented without any flexibility, the manufacturing sector would not have been able to cut back so many jobs.

At the micro-level, there are multiple factors which affect the decision-making tact of the firms such as the product market, the inputs market, the nature of the industry, the state in which the industry is located, number of workers, the orientation of the government in power towards the business, the power of trade unions and available technology (Sharma, 2006). Micro evidence suggests that the wage growth rate has remained stagnant but the output has increased which can be seen in the increase in labour productivity. Since the wage-rental ratio (the ratio between the labour wages and the rental price of capital or land) has also declined, it can be inferred that increase in output is not an outcome of more employment of labour against the capital.

Therefore, the driving force of the increased productivity could be explained with an increase in modernization or uses of technology i.e. increase in capital per unit of labour (Nagraj, 2004).

Workers have been unable to take advantage of improved labour productivity as the real wages have remained stagnant. The benefits of the structural policy changes of 1991 have been reaped by the employers or the consumers. The employers have been able to survive this reform based on the additional funds they had collected from reducing the labour cost. Nagraj also points out that workers are consumers as well and the purchasing power of the consumers would have gone down because of job cuts resulting in lower demand for manufacturing sector output (Nagraj, 2004). Other indicators highlighting the presence of labour reforms in the market were the increase in the number of contract workers to the total workers which clearly indicated that the formal sector jobs were reappearing in the unorganized sector through sub-contractual agreements (Nagraj, 2004); the percentage of contract labourers went up from 19 per cent in 1990 to 23 per cent 2002 (Sharma, 2006). The individual state-level experiences were similar; Andhra Pradesh experienced a surge in contract labourers from 40 per cent in 1990 to 62 per cent in 2002 (Nagraj, 2004). The increase in contract labourers and the government's encouragement of this phenomenon through labour regulations clearly shows that labour regulations were not hampering the growth of the manufacturing sector because of “insincere implementation,” as reiterated by the critiques of inflexible labour laws in India (Nagraj, 2004).

The state of West Bengal had a highly active political scenario in the favour of the workers but by the end of the 1980s, there was a decline in the traditional industry comprising jute and paper mills. The state government was under the pressure for job creation from the working class and therefore, they allowed liberalization in the state as they saw positive implications of the abolition of licenses. Despite all these changes, the informal sector was performing better than the formal sector in terms of job creation which was not uncommon in other states. But the uniqueness of the West Bengal experience was that the informal manufacturing sector performed better than the formal sector with respect to the output as well. The astonishing fact was that the labour productivity was increasing as a lesser number of workers meant the said work was done by fewer people now and therefore, productivity (output per worker) by each worker was more as compared to what it would have been with more workers. Notwithstanding the increased productivity, the rate of growth of this labour productivity was declining.

Additionally, wages were increasing. The trade unions had a role to play in the swelling wages despite the low rate of growth of labour productivity. The trade unions worked only for improving the conditions of the workers inside the system without concerning themselves with the workers outside the system i.e. the contractual workers. The consequential increased liquidity from the subcontracting was used to increase the wages of existing permanent workers instead of pushing for more employment by making contractual labour permanent (Chakravarty & Bose, 2011). All the aforementioned macro and micro evidence are strong indicators of an imbalanced relationship between employers and employees during that time.

During that time, the resistance from the trade unions eased up and this was evident from the fall in the number of strikes and lockouts all over the nation (Papola & Pais, 2007). There were more lockouts as compared to the strikes showing the poor bargaining power of the labour class. The major effort of trade unions was focused on getting better remunerations in case of retrenchment or helping in improving the wages.

By now, we have established that there were enough reforms in labour regulations and therefore, the mediocre manufacturing sector performance was not an outcome of the rigidity of the labour market. The argument that labour market reforms facilitate the growth of the manufacturing sector is misplaced as most of the labourers are not even covered under these regulations.

Even in recent years, the formalization of labour by enacting several laws to protect the interests of the labourers has been insufficient to show the dependence of manufacturing sector growth on labour laws. There needs to be a focused discussion on whether the changes made in labour laws by UP and Madhya Pradesh could actually bring any change in productivity given that these changes are only formalizing the existing practices.



1. Chakravarty, D., & Bose, I. 2011. Industry, Labour and the State: in the Indian State of West Bengal. Journal of South Asian Development, pp. 169-194.

2. Kotwal, A., Ramaswami, B., & Wadhwa, W. 2010. Economic Liberalization and Indian Economic Growth: What's the evidence? New Delhi: Indian Statistical Institute.'s_the_Evidence

3. Nagraj, R. 2004. Fall in Organised Manufacturing Employment: A Brief Note. Economic and Political Weekly, Vol. 39, No. 30, pp. 3387-3390.

4. Panagariya, A. 2004. Growth and Reforms during the 1980s and 1990s. Economic and Political Weekly, pp.2581-2592.

5. Papola, T., & Pais, J. 2007. Debate on Labour Market Reforms in India: A Case of Misplaced Focus. The Indian Journal of Labour Economics, Vol. 50, No. 2, pp. 183-200.

6. Sharma, A. N. 2006. Flexibility, Employment and Labour Market Reforms in India. Economic and Political Weekly, Vol. 41, No. 21, pp. 2078-2085.

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