Impact of labour market regulations on industrial performance : evidence from Indian manufacturing sector

Abstract

There have been wider debates among the economists and policy makers regarding the sluggish performance of Indian manufacturing sector over last couple of decades. The so-called structural transformation – major shift in employment towards industrial sector – has not been happening the way envisaged by economists, especially in developing countries like Indian. The share of manufacturing output in total GDP has remained meagerly low. Over the last ten years, there has been a substantial growth in output of manufacturing sector; it has not accompanied employment generation, however. The principal factors that are generally held responsible for hobbling the manufacturing sector, particularly its abysmal record on employment, are (among others) lack of infrastructural facilities and non-availability of credit. However, for last two decades, there has been a considerable shift in the attention of economists and researchers towards investigating the potential impact of labour regulations on employment, output, and labour productivity. Labour laws are widely being cited as one of the principal factors which many researchers and policy makers believe are to be blamed for creating rigidities and holding back employment and productivity growth in industrial business. A substantial body of theoretical literature explains that employment protection legislations (EPL), which give rise to firing costs, can stifle employment generation, output, and productivity growth by creating rigidities (see, for example, Nickel, 1986;Hamermesh, 1993). Besides, there also exists a substantial body of empirical literature from developed as well as developing countries, linking industrial performance with employment protection legislation (EPL).While being exposed to rising competition in markets due to rising tide of globalization, employers have been vehemently complaining against EPL, citing that it has distorted optimality in production by limiting numerical flexibility (Sunder, 2012). Employers, legitimize their demand for flexibility in hiring and firing, claim that with the advent of globalization and the pressures thereof, firms require employment adjustments all the more to produce an optimal output – to keep up with the volatile market – with optimal level of labour employment. Any level of output produced with sub-optimal level of labour-input is bound to impinge on the efficiency, and thereby, drive the firms out of the competitive markets.Although a substantial body of empirical-literature has been accumulating internationally and/or nationally– investigating the economic impact of EPL, yet there is a lack of unanimity among the researchers on the extent to which labour laws are responsible for discouraging industrial investment, employment generation, and hurting productivity (Betcherman, 2014). A substantial body of literature disputes the "rigidity argument" on the ground that there are several ways (e.g. employment of non-regular or contract workers) by which employers have been able to evade the brunt of labour laws. There has been a sharp growth in informal employment which is often considered as flexible labor as it most often does not fall under the purview of what is believed to be directly related with rigidity – employment protection legislation. The incidence of contractual and casual employment has increased substantially in OECD countries also (OECD, 2007). Likewise, it has increased four times in Scandinavian countries, and has nearly doubled in European countries over last the two decades (CIETT, 2007). Same is the case with Australia (Ruyter and Burgess, 2003). Coming to India, there has been a sharp growth in informal employment, even in the formal manufacturing sector where the contractual employment has, as per annual survey of industries, increased from 13 % in 1993-94 to 35 % in 2010-11 (Sunder, 2012).