Has India Peaked? (Part 2)


Has India Peaked? (Part 2)

Has India peaked? This may seem like a strange question given the strong economic growth the country has experienced since it liberalized its economy in 1991. Together with China, India is widely regarded as the greatest global economic success story of the past quarter century, with growth rates typically ranging between 5 and 10 percent.1 Although its growth rate has declined recently to less than 5 percent due in part to the global economic downturn, the landslide victory of the strongly pro-business BJP (for Bharatiya Janata Party, or Indian People’s Party) in the spring 2014 elections has convinced many that it will begin trending up again in the near future.

Restrictive Labor Laws

So, why is it that India has followed this IT-driven growth pattern rather than follow in the footsteps of China, and virtually every developed economy on the planet, in pursuing labor-intensive growth? After all, India has a population roughly equivalent in size to that of China and, therefore, possesses an enormous pool of potential factory workers whose services could be obtained for what, in global terms, would amount to a pittance. The primary reason is the existence of restrictive labor laws that make it virtually impossible for employers to lay off, or fire, workers in response to changing market conditions. These laws were untouched by the reforms of 1991.

Under the Industrial Disputes Act (IDA) of 1947, as amended in 1982, it is illegal for any industrial enterprise with more than 100 workers to lay off, or fire, any employee without getting permission from the government. Because of the constraints built into the Act, which are heavily weighted in favor of worker rights, the government bureaucracy that administers it rarely grants such permission.11 The literature is full of horror stories about employers who ended up having to spend years and considerable resources just to get rid of a single bad employee.12 As a result, any businessman considering starting up a large-scale industrial enterprise in India, or expanding an existing one beyond 100 employees, must be prepared to treat labor as a sunk cost.

Not surprisingly, most potential investors in the manufacturing sector are unprepared to go down this road. Those that do, or who already employ more than 100 workers, try to get by with workarounds. One of the most common is the use of contract labor, which is exempt from the IDA. Contract employees are hired on a temporary basis, generally paid less, and can be laid off when their services are no longer required. Their availability, however, is itself constrained by legislation. In practice, contract workers can only be hired to supplement an existing full-time, fully protected industrial workforce, and even then, individual Indian states have the ability to ban them from certain sectors altogether. Where contract labor is employed, it frequently becomes a source of friction between full-time employees, who enjoy full IDA protection, and their less fortunate colleagues. It is a workaround for businesses in a tight spot, not a panacea.13

Another common workaround is automation, replacing live workers with machines to the maximum extent possible. This is how the giant Tata Group steel mill in Jamshedpur succeeded in reducing its workforce from 85,000 in 1991 to 44,000 in 2005.14 This kind of workaround is, in fact, symptomatic of the overall capital-intensive approach to economic development that has dominated the Indian economy since 1991. The IT sector has driven the Indian economic miracle not simply because Nehru did something right in establishing the Indian Institutes of Technology, but because of its relatively small size and capital-intensive nature.


Opposition to Labor Law Reform

Although restrictive labor laws explain why the IT sector has driven Indian economic growth since 1991, it does not explain why India continues to maintain such outdated legislation. After all, while the Indian economic miracle may have lifted tens of millions of Indian people into the middle class, it has left more than a billion of them on the outside looking in, living on less than $4 a day, with more than two-thirds on less than $2. Surely, the people of India would be immeasurably better off today if 100 million more of them had been able to find jobs in the manufacturing sector, as in China.

A large part of the reason goes back to the socialist roots of the state. We have already seen how deeply the Soviet model influenced Nehru, with its emphasis on central planning and import substitution. But unlike the Soviets, he was unwilling to fully nationalize the means of production, and therefore was not in a position to guarantee Indian workers a job. Instead, the IDA succeeded in guaranteeing that those workers lucky enough to find jobs could look forward to keeping them for the rest of their working lives, no matter what.

This socialist strain in the Indian approach toward business and labor, however, has been slow in dying. Although many of the worst aspects of the License Raj were swept aside during the balance of payments crisis of 1991, nothing of similar magnitude has occurred with respect to the restrictive provisions of the IDA. One obvious reason for this is that, ironically, the substantial IT-led growth that has taken place since 1991 has tended to dampen any sense of urgency that might have developed in favor of labor law reform.

Many Indians, particularly from the upper castes, also have a romanticized attraction to “village India”, which would disappear in the face of massive industrialization. This includes the small-scale “mom-and-pop” manufacturing and retail establishments that are its economic cornerstones. Gandhi, of course, was the most famous champion of village India. He wanted to retain the village as the centerpiece of Indian social, economic, and political life in the apparent belief that it was somehow ennobling for people to live on less than $2 a day.15 Even today, there is strong sentiment in India against buying up village land to make way for industrial enterprises.16

Some economists have even argued that labor law restrictions are not responsible for the failure to move in the direction of labor-intensive industrialization. They say the real culprit is the admittedly deplorable state of infrastructure in India, particularly in the energy and transportation sectors.17 Indians still have vivid memories of the July 30-31 power blackouts in 2012, the largest in world history, which affected half of the Indian population. And anyone who has driven on Indian roads can testify to the chronic difficulty in transporting goods of any kind to market. But these are the kinds of problems that affect all developing economies. The way things work in the real world is that industrialization and infrastructure improvements typically go hand-in- hand. If anything, the failure of India to move toward labor-intensive growth has retarded efforts to improve the country’s infrastructure by once again removing the sense of urgency.

Other economists have pointed to business confidence surveys, which rarely cite restrictions on laying off or firing workers as a problem. In response, Jagdish Bhagwati and Arind Panagariya have pointed out that most of the businessmen surveyed operate in either the service sector or capital-intensive enterprises, where labor law restrictions are not a major problem. Once again, this is more a consequence of the fact that India has failed to pursue labor-intensive growth than evidence that labor laws have not played a major role.18 At the end of the day, in order to believe all these skeptics, you have to be willing to believe it is simply an amazing coincidence that India has the most restrictive labor laws on the planet and also happens to be the only late-developing country that has failed to pursue labor-intensive growth.

Not surprisingly, the strongest opposition to reforming India’s labor laws comes from the political left, dominated by the trade union movement, and the Left Front, a grouping of political parties led by the Communist Party of India- Marxist or CPI(M). These parties oppose any effort to water down the job security guarantees contained in the IDA, even though they currently protect fewer than 10 million industrial workers.19 They would, presumably, be happy to see these ranks grow to the levels seen in China, but not through capitalist expansion, which they regard as inherently exploitative. The solution favored by the CPI(M) would be to nationalize the means of production, which is what Nehru failed to do. The fact that this led to less than desirable outcomes in places like the Soviet Union appears not to deter them.

Although the CPI(M) is a force to reckon with in states like West Bengal and Kerala, it has no hope of dominating the national political stage. The Left Front held only 24 seats in the outgoing 543-seat Lok Sabha and has only 10 in the new one. On the other hand, it did manage to win 60 seats in the 2004 elections. This gave it real influence over policy, since the plurality achieved by the victorious Congress-led coalition was so narrow, it felt the need to rely on Left Front support for much of its term in office. Needless to say, there was little prospect of significant labor law reform during this period.

But the traditional political left is not the only force in Indian politics opposed to labor law reform. Over the past two decades, a series of so-called lower-caste parties have sprung up in India, primarily in the massive Hindi belt in the north, an area that also happens to be the poorest and most backward part of the country. These parties are inherently socialist in political orientation and ostensibly represent the interests of the historically most underprivileged groups in Indian society. Uttar Pradesh, by far the most populous Indian state, is dominated by two such parties, the BSP (which claims to speak for the Dalit or untouchable community) and the rival Samajwadi party (whose constituency is drawn from the so-called Other Backward Classes, an amalgam of lower-caste and Muslim groups). Politics in Bihar, the poorest and third-most-populous Indian state, has also been dominated by two primarily lower-caste parties—the Janata Dal (United) and its main rival, the Rashtriya Janata Dal. Together, these four parties held down 68 seats in the previous Lok Sabha. At one time or another, the Congress-led government that was elected in 2009 had to rely on support from at least three of them to maintain its majority in parliament.20

This affected prospects for labor law reform because these parties see their primary task as obtaining patronage for their supporters in the form of government jobs, which can be delivered through political patronage.21 When it comes time to form national coalition governments, these parties typically offer support to one of the two national parties, Congress or the BJP, in return for promises that their members will obtain special access to such jobs. When the parties are in power at the state level, as the Samajwadi and Janata Dal (United) parties currently are, they can offer this patronage more directly. The jobs on offer may be low-paying, but they typically require little effort on the part of those who fill them.

In his highly perceptive book on modern India, In Spite of the Gods, Edward Luce gives an example of where this can lead. He notes that the highway department in Uttar Pradesh employs one worker for every mile-and-a-half of road, one of the highest ratios in the world, yet it has one of the most poorly maintained road systems in India.22 Even more importantly, thanks to the restrictions on laying off and firing workers enshrined in Indian labor laws, such jobs are secure for life. Since their ability to obtain them for their supporters is their primary selling point, these lower-caste parties oppose labor law reform even though their fellow caste members would undoubtedly be the primary beneficiaries.

Up until the 2014 elections, this Left Front and lower-caste party opposition to labor law reform has proved dispositive. During their respective periods in office, neither Congress nor the BJP have been willing to risk their hold on power by making labor law reform a major issue. Although former prime minister Manmohan Singh periodically spoke out in favor of reform, as a patronage-based party with both socialist and Gandhian roots, Congress has always felt more comfortable relying on subsidies and make-work social welfare schemes (such as offering to pay struggling farmers to dig ditches) to address the plight of India’s poor. The BJP, by contrast, has long marketed itself as the party of business, and the Vajpayee government in power from 1998 to 2004 came out in favor of labor law reform. But given its own dependence at the time on lower-caste party support to maintain its parliamentary majority, it did not try to push the issue forward. Even during the 2014 election campaign, the party declined to stick its head above the parapet on the issue. It barely rated a mention in the BJP’s election manifesto, which pledged only to “bring together all stakeholders to review our Labour laws which are outdated, complicated and even contradictory.”23

The basic problem that both Congress and the BJP have faced in contemplating labor law reform is that neither party has been able to command a majority in the Lok Sabha on their own. Prior to this year, the last party to do so was Congress, which overwhelmingly won the 1984 elections held in the wake of the assassination of Indira Gandhi. The years that followed saw the balance of power at the national level pass from their hands into those of much smaller regional parties, some of whom, as we have seen, are organized around lower-caste identities and located primarily in the Hindi belt. Other regional parties scattered across the country are ethno-linguistic in composition and associated with the majority population in particular states, particularly in the south. Together with the Left Front, these regional parties actually commanded a majority of the electorate during the 2004 and 2009 Lok Sabha elections. (Cont.)


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