India is midway through its demographic dividend <what is demographic dividend? Answer in comments>. To exploit this dividend India’s economy needs to do three things-

1. Movement of workers from agriculture to industry <pull factor of higher income in industry not push factor of distress in agriculture>
2. Shift of workers from informal to formal sector < good jobs– jobs that are safe and pay well, and encourage firms and workers to improve skills and productivity>
3. Rapid urbanization <it will automatically follow industrialization>

Note 1- there is lot of confusion b/w informal and unorganized sector. For the sake of simplicity, sectors not covered under factory act, 1948 (<10 workers with power, <20 without power) is unorganized sector. Informal sector is virtually synonymous with it.

Note 2- Formal jobs are jobs with some social security i.e insurance, pension, provident fund etc. Formal jobs would be there in organized or formal sector only but in formal sector, there can be informal jobs i.e contract workers not provided with social security.

Note 3-  NCEUS estimated in 2005 that out of total 470 million workers, there were 423 million informal workers in India of which 395 million belonged to the informal sector. The remaining 28 million were informal workers in the formal sector. <You can do the math of percentages>

For detailed information regarding, formal/ informal click here 

Let’s come back to main topic

Of the 10.5 million new manufacturing jobs created between 1989 and 2010, only 3.7 million (35%) were in the formal sector i.e. informal firms account for most employment growth, that’s why the need to promote entrepreneurship.

But informal sector jobs are much worse than formal sector jobs as-

1. Wages are, on average, more than 20 times higher in the formal sector.
2. Formal sector jobs also score better on some non-pecuniary grounds. For example, they allow workers to build employment history— which is important for gaining access to cheaper formal credit, getting better jobs in other enterprises.
3. Social security

Thus the challenge of creating “good jobs” in India could be seen as the challenge of creating more formal sector jobs, which also guarantees worker protection.

But why have formal sector jobs not increased? Also why has informalization < hiring of contract workers >increased even in formal sector jobs.

One of the reason is complex maze of labour laws which raise compliance costs as firms hire more workers forcing them to stay small. Needless to say, employers have started to get around them and one of the strategy is use of contract labour which is leading to informalisation of formal sector.  Also in the absence of reforms by parliament, states have taken upon themselves the task of reforming labour laws. You can read more abut need for reforming labour laws in this story, labour reforms in India

Contract Labour

It provides two key benefits:

1. The firm essentially subcontracts the work of following regulations and managing inspectors to the contract labour firm
2. Because contract workers are the employees of the contractor and are not considered workmen in the firm, the firm stays small enough to be exempt from some labour law (<10 employees not under factory act, <100 employees not under industrial dispute act>

For these reasons, contract workers increased from 12% of all registered manufacturing workers (formal sector workers) in 1999 to over 25 per cent in 2010.

But this strategy is not without costs

1. Hiring workers through a contractor can be more expensive
2. Contract workers do not feel as much loyalty to the company as regular workers would, reducing employers’ incentive to invest in their training <low skilled workers, low productivity>
3. Worker protection and worker rights go down the drain

Hiring contract workers today hurts a firm’s productivity tomorrow, precisely because contract workers do not accumulate firm specific human capital.

Competitive federalism

As labour comes under concurrent list <lists come under which schedule of constitution? What’s the procedure for amending the various lists? Answer in comments>, states have taken initiatives to reform labour laws. <But how can states enact laws repugnant to central laws? Answer in comments>

So Rajasthan govt has amended various labour laws <Quote these in mains answer or essay>

1. Industrial Disputes Act– government permission will not be required for retrenchment of up to 300 workers <only 100 workers in central act>
2. Trade Unions act- increased the percentage of workers needed for registration as a representative union from 15 per cent to 30 per cent<necessary as trade unions have become highly politicized>
3. Contract Labour Act -the amendments raise the applicability of the Act to companies with more than 50 workers from the current 20
4. Factories Act– currently applicable to premises with more than 10 workers with power and 20 without power, the amendments raise these numbers to 20 and 40, respectively

Good labour reforms should simultaneously increase social security and worker protection <unemployment allowance, reskilling of workers, pension, insurance etc> but Rajasthan govt has not any step in that direction in labour reforms.

There may be a possibility of competitive federalism becoming too competitive, inducing a race to the bottom with states pushed into giving too many concessions. But India seems far from such a situation. For example, changes that certain states are considering—such as Haryana’s proposed online filing of returns through a single form covering 12 separate labour laws and e-maintenance of all labour-related records—would likely improve compliance and worker welfare

Labour reforms help in entry of large firms <as compliance cost decreases, there is no incentive to remain small or any disincentive to hire more workers> and the benefits of the entry of a large manufacturing company to a state can go beyond scale, depending on the kind of products they manufacture. How ans Why-

1. What you export matters because exporting develops a country’s local know-how and supply chain networks, bringing it closer to the global frontier for the exported good <best product available in world market>
2. Skills may be more transferable across certain industries than others. For example, it may be easier to make cars—a complex product—once a country has developed expertise in making bicycles—a simpler but related product.
3. In this sense, what a country manufactures today matters not just because it affects employment and growth today, but also because it shapes the set of products a country can profitably produce tomorrow
4. For instance when China first entered the mobile phone assembly space, it was producing only electrical connectors and cables; now it is producing sophisticated, high growth and high valued-added products such as smartphones and tablets.

Lesson is that we should promote entry of manufactures which help develop know how which can be transferred across sectors to move to manufacturing high value addition goods with mobile phone manufacturing being a good example.

Relocation

Apart from the complex maze of labour regulations, there are some other factors which prevented development of labour intensive manufacturing in India

1. High cost of living in metros <it increases labour cost>
2. High transport and logistics costs and weak connectivity from suburbs to metro  <good connectivity and low cost transport would allow workers to commute to work to metros>
3. Low female labour force participation rate <suitable jobs not available near their homes>

For instance apparel industry is highly labour intensive, with 30% of costs from wages. Only 2-3% of costs are due to capital-intensive inputs like power. And yet India is ceding market share in the global apparel industry to countries like Bangladesh and Vietnam.

Formal sector apparel firms are about 15 times more productive than informal sector yet India’s apparel sector is dominated by informal firms while in China there are large apparel firms and now other countries are taking over.

To get around this some firms are now reloacting to smaller town and rural areas and it has several benefits for economy-

1. It spreads economic development to underdeveloped areas
2. Reduces spatial mismatch in the labour market <workers can work near their homes>
3. Improve competitiveness by raising firms’ access to lower cost labour <low cost of living in smaller towns>
4.  It improves female labour force participation, more earning, financial security for women, women empowerment but? How <very very important>

• Most explanations of low labour force participation in India focus on supply side factors like cultural norms that frown on women working outside the home
• Less attention has been given to demand-side explanations, which essentially emphasise that a key determinant of female labour force participation (LFP) is the availability of suitable jobs <flexible jobs near their homes>
• It is a striking fact that the areas in India that have seen the greatest decline in female labour force participation in the last decade are those villages that have rapidly urbanised and are now part of towns and small cities.
• Farming jobs in these areas are no longer available, but women-friendly service sector jobs are yet to take their place

From this perspective, female LFP can be expected to depend on the availability of ‘suitable jobs’, which are flexible and located close to home located in small cities, utilizing women’s comparative advantage in garments, flexible working hours and childcare on site

Till know we say how firms are getting around the problem and how states are reforming labour laws but what should be the centre’s role?

It should be to ensure worker centric labour regulations by expanding workers’ choice and reducing mandatory taxes on formal sector employment.

Let’s understand this with the example of epf

What is EPF?

Employees provident fund is a scheme under which it’s mandatory for workers (organized private sector workers) earning less than 15k to deposit 12% of their income in EPF account. Employers contribute equivalent amount. EPFO invests it in mainly govt securities and they get annual interest rate based on return. They get principal plus interest at retirement thus it is meant to provide lump sum benefits to workers at the time of retirement.

Higher income individuals are not mandated to deposit any amount but they still do to take advantage of EEE provision. Read more about this provision and subsidy for rich in this economic survey chapter

Let’s analyse impact of EPF on workers-

1. From worker’s choice perspective, they are being forced to deposit significant proportion of salary in EPF (12% when they already earn so little)
2. They don’t get any tax advantage either (already outside tax bracket)
3. Various surveys have suggested workers would rather like cash in hand as majority of them are liquidity constrained
4. Further it’s difficult to access the account.

Though govt has taken some initiative to make it easier for them to access the account. For instance, uniform single account number portable across jobs and locations, e-filing and e-withdrawal etc, survey suggests giving workers the choice to get cash, remain in epf or move to NPS while keeping employers’ contribution intact.

Giving choice is important as EPF has high administrative costs. The EPFO requires that employers pay an administrative charge of 0.85% of the worker’s salary. This may not seem large, but it amounts to service charges of 3.54% (=0.85/24) which are higher than the rates of most private mutual funds. Competition will help bring down administrative cost.

Govt sought to reform EPF but buckled under pressure and rolled back all three reforms

Three EPF fliplops

1. Tax on withdraw- At present epf is EEE.  Proposal entailed taxing 60% of withdrawals and if that 60% is used to buy annuity it would be tax free i.e 40% of withdrawal tax free, tax on 60% if no annuity is bought

What is annuity-

It is a form of insurance or investment entitling the investor to a series of annual sums. Basically if you have 1000 rs and you buy annuity, pension fund manager will invest it in bonds and equities and you will get some amount every year based on your initial corpus and return on investment

Talking about annuity, why don’t you revise the hybrid annuity model of PPP project here

Objectives

• Idea was to make EPF equivalent to NPS which earlier was an EET scheme. Subsequently 40% was made tax free and remaining 60% would be tax free if used to buy annuity.
• Ultimate aim was to make India a pensioned society. As lump sum withdrawals are often used immediately, there’s nothing left for rest of the life. Learn about social security schemes in India here 

Protest– Of course salaried class wouldn’t like this idea. Government has no business deciding for them what they do with their money plus taxation is big no.

2. Restrictions on premature withdrawal -It was announced that workers will not be able to withdraw employer share till 58 years of age. At present, they can empty entire corpus if they remain unemployed for two months or at 54 years of age.

Objective– Idea was to prevent premature withdrawals so that something is left for the old age

Protest– It;s our money. you govt don’t tell us what to do. Further, often times we don’t have any job after 50 years of age. How would we survive for eight years without EPF money.

3. Reducing interest rate on EPF to 8.7% from 8.8%-

Objective-

• Aligning them with market determined interest rates. If all interest rates are falling and return on govt securities also falling as inflation comes down, there’s no reason for epf interest rate to not fall
• As in future even inactive accounts will get interest benefits, future surplus would fall and future rates would come down drastically, so start cutting rates now <at present accounts which show no activity for three years don’t get any interest>

Protest- that EPFO had generated enough return to warrant high interest rates

What I don’t understand is how EPFO generate such a high rate of return when it invests almost entire corpus (95%) in govt securities and if everything is to be invested in govt securities, what’s the need of an organization called EPFO? <Ye mere man ki baat hai>

Before we end this chapter, let’s learn in brief about National Pension Scheme (NPS)

• It is a pension scheme <defined contribution scheme i.e. employees contribute while they earn and get pension according to corpus accumulated during the working years> which is mandatory for govt workers (except armed forces) who joined the service after 1st july 2004. <Earlier there was defined benefit scheme in which pension amount was fixed based on years of service
• Employees deposit 10% of their salary which matching amount by govt.
• Even private sector workers can choose to invest in NPS voluntarily (unorganized sector workers not covered under EPF) <EPF is compulsory and only salaried employees under organized sector can invest in EPF>
• Minimum investment towards NPS is 6000 rs per year
• With NPS, people have the flexibility to choose between different asset classes to invest in — equity, corporate bonds and government securities <In EPF >90% investment in govt securities while NPS is allowed to invest up to 50% in equities>
• As people get to take some exposure with equity, they can earn higher returns over the long term <flip side is that there is no assured return in NPS while there is assured return on EPF>
• The Pension Fund Regulatory and Development Authority(PFRDA), an agency under the administrative control of the Finance Ministry is the regulator

Read about all the labour reforms of the present govt here