The Case For Labour Law Reforms

Arguments and evidence in favour of the current spate of labour law reforms. 

Several Indian states have suspended or diluted labour laws over the past couple of weeks. This move has garnered support from a number of commentators who believe that labour laws in India have hindered economic activity, growth, competition and formalization of the economy. 

Does this line of thought have support in theory? Both sides of this debate do. 

Arthur Cecil Pigou's public interest theory of regulation [1938] holds that unregulated markets exhibit frequent failures, ranging from monopoly power to externalities. 

On the other hand, in line with the supporters of on-going deregulation, the public choice theory [Gordon Tullock, 1967; George Stigler, 1971; Sam Peltzman, 1976] sees the government as less benign and regulation as socially inefficient. It comes in two flavors. 

In Stigler's theory of regulatory capture [1971], "regulation is acquired by the industry and is designed and operated primarily for its benefit, keeping away competition.” 

A second strand of the public choice theory, which we call the tollbooth view, holds that regulation is pursued for the benefit of politicians and bureaucrats.

There are plenty of half-baked studies that support the latter theory but it is difficult to vouch for their validity on account of the dubious econometrics deployed.

We have, however, found two papers that come close to finding evidence to support this thesis. The evidence from these papers can be regarded to be as close to robust as can be possible without a gold standard Randomised Control Trial. 

The first paper is called ‘The Regulation Of Entry’ and is authored by Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes and Andrei Shleifer (2002), published in the Quarterly Journal of Economics (2002).

The paper asks two questions– 

First, what are the consequences of the regulation of entry, and in particular, who profits from it? If the regulation of entry serves the public interest, it should be associated with higher quality of goods, fewer damaging externalities, and greater competition. 

A second question they ask is what kinds of governments regulate entry? 

They consider data from 85 countries and record the number of legal requirements that need to be met before a business can officially open its doors, the official cost of meeting these requirements, and the minimum time it takes to meet them if the government does not delay the process. 

- The number of procedures required to start up a firm varies from the low of 2 in Canada to the high of 21 in the Dominican Republic, with the world average of around 10. 

- The minimum official time for such a start-up varies from the low of 2 business days in Australia and Canada to the high of 152 in Madagascar, assuming that there are no delays by either the applicant or the regulators, with the world average of 47 business days. 

- The official cost of following these procedures for a simple firm ranges from under 0.5 percent of per capita GDP in the United States to over 4.6 times per capita GDP in the Dominican Republic, with the worldwide average of 47 percent of annual per capita income. 

For an entrepreneur, legal entry is extremely cumbersome, time-consuming, and expensive in most countries in the world. 

In a cross section of countries, we do not find that stricter regulation of entry is associated with higher quality products, better pollution records or health outcomes, or keener competition.

But stricter regulation of entry is associated with sharply higher levels of corruption, and a greater relative size of the unofficial economy.

In answer to the second question - What kinds of governments regulate entry? - they find that the countries with more open access to political power, greater constraints on the executive, and greater political rights have less burdensome regulation of entry - even controlling (adjusting) for per capita income - than do the countries with less representative, less limited, and less free governments. 

The main limitation of the paper is that it is a cross-sectional analysis– as opposed to a time-series analysis where one can gauge the impact of a policy over time. For complete details of how the data is collected, what controls, proxies, and variables are used, and regression tables, read the study.

The next paper is perhaps the most influential paper in this context, and examines evidence from India. 

‘Can Labor Regulation Hinder Economic Performance? Evidence From India’, by Timothy Besley and Robin Burgess, published in the Quarterly Journal of Economics (2004). 

Indian states have pursued different regulatory paths and have very different economic performance– this experience in India yields both time series and cross-sectional variation in regulation.

The Indian case is also interesting because the regulations that are being examined impact a particular sector– registered manufacturing. Therefore it does not impact firms that are smaller than a certain size.

Exploiting these two features, the paper asks whether there is a strong link between labour regulation and economic performance. It is important to bear in mind that manufacturing performance impacts both economic growth and poverty reduction.

In particular the paper looks at the Industrial Disputes Act of 1947 and sets out the conciliation, arbitration and adjudication procedures to be followed in the case of an industrial dispute. This Act has been extensively amended by state governments during the post- Independence period. These amendments are coded in the data set such that each amendment is read and its contents are coded as pro-worker, pro-capital or neutral [1, 0, -1].  

For eg.:- 

Andhra Pradesh: 1987: (Pro-employer): If in the opinion of the state government it is necessary or expedient for securing the public safety of the maintenance of public order or services or supplies essential to the life of the community or for maintaining employment or industrial peace in the industrial establishment, it may issue an order which-

(i) requires employers and workers to observe the terms and conditions of an order and 

(ii) prohibits strikes and lockouts in connection with any industrial dispute.

West Bengal: 1980: (Pro-worker): The rules for lay-offs, retrenchment and closure may according to the discretion of the state government be applied to industrial establishments which employ more than 50 workers. (Under the central act, these rules only apply to establishments which employ more than 300 workers.)

It is important to bear in mind that this Act only controls registered manufacturing firms as defined by the Factories Act, 1948. 

The paper looks at–

- The years between 1958-1992: The whole span of planning period up to liberalization in 1992. 

- Data from the Annual Survey of Industries for impact of labor regulation on manufacturing performance and the National Sample Surveys for impact of labor regulation on poverty.

They find, for eg.:-

That Andhra Pradesh grew at 6 percent per annum and predict it would have had 4.1 percent growth with no policy change. They also predict that it would have had registered manufacturing output which was 72 percent of its 1990 level without policy change. 

West Bengal, on the other hand, grew at -1.5 percent per annum. They predict the growth would have been 2.2 percent with no policy reform and that its registered manufacturing output would have been 24 percent higher than its 1990 level without policy change. 

Urban poverty in Andhra Pradesh would have been 112 percent of its 1990 level without policy change.

Urban poverty in West Bengal would have been 89 percent of its 1990 level without policy change.

Overall, they find that an increase in the bargaining power of labor through pro-worker amendments: 

(i) reduces output, capital formation and employment in the registered manufacturing sector; 

(ii) increases output in the unregistered manufacturing sector and 

(iii) reduces overall manufacturing output. 

Details of data, theory, model, and empirical evidence can be read here.

However, this paper’s conceptual framework, methodology, coding, and findings, and the influence it has had on policy have been seriously critiqued and questioned. You can read two of these critiques here and here

For a list of arguments against removing protections and rights of workers, please read our article on The Case Against Labour Law ‘Reforms’.

This article is the third in an Indian Policy Collective series on the extremely polarised Labour Law debate.

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