Abstract
Since the pioneering paper by Besley and Burgess (2004) claimed to have found a positive relationship between flexible and pro-employer labour regulations with manufacturing sector performance, there has been an increasing pitch among policymakers to rationalise India’s complicated labour laws. Several state governments have since undertaken significant reforms in their respective labour law regimes. During the recent pandemic-induced lockdown, some states have gone to the extent of temporarily suspending labour laws to kick-start the economy. The Government of India has also recently consolidated the fragmented labour laws by integrating them into four functionally arranged Codes. But the regulatory measure developed by Besley and Burgess, the very basis of their conclusions, has been criticised on the ground of narrow coverage, methodological inconsistency, misclassification of amendments, etc. This article, therefore, attempts to construct a comprehensive Index by mapping state level-amendments in five important labour legislations over the seven-decade period from 1949 to 2017 and coding those amendments. The article is organised as follows: After the context-setting introductory section, the second section summarises the existing evidence on the relationship between labour regulations and manufacturing sector performance in India. The third section discusses the limitations of Besley–Burgess Index. The fourth section briefly mentions the research direction post publication of Besley–Burgess paper. The fifth section develops a comprehensive Index, and it discusses how it improves the BB Index. The sixth section concludes the article.
Keywords
Introduction
India is a country with a young population, with a median age of 28.4 (United Nations [UN], 2020). Such a young population profile means an inevitable demographic bulge, with a million youth entering the economy every month in search of employment (Department of Economic Affairs [DEA], 2015, p. 107). Agriculture and allied sectors are still, by far, the largest employer in India, accounting for 43% of the workforce. However, agriculture is characterised by low productivity and concealed unemployment, 43% of the workforce contributes only about 15.4% of the gross domestic product (GDP) (World Bank, 2020). Even for the rural economy, agricultural activities account for only one -third of the net product, although more than 60% of the working population is still dependant on agriculture (Roy & Mukhopadhyay, 2019, p. 93). To unlock the full potential of demographic dividend, and to reduce overcrowding in agriculture, India needs to create plenty of jobs in the industrial and service sectors for many years to come.
While there has been some growth in employment in the industrial and service sectors recently, the growth has mostly been in the informal segment of the economy (90% by some estimates) (Salve, 2019). However, the quality and reasonably well-paid jobs with a modicum of social security are almost entirely in the formal sector. The Economic Survey 2015–2016 (DEA, 2016, p. 140) aptly notes ‘To exploit its demographic dividend, India must create millions of “good”—safe, productive, well-paying—jobs. These tend to be in the formal sector’.
Summary of Four Codes.
Summary of Four Codes.
While the labour regulations are extremely critical in providing a modicum of job security and ensuring decent working conditions, these very laws have often been cited as a major hindrance for the organised manufacturing sector to expand rapidly (DEA, 2014, p. 48). The Economic Survey (2005–2006) stated:
Various studies indicate that Indian labour laws are highly protective of labour, and labour markets are relatively inflexible. ……. Labour being a subject in the concurrent list, State-level labour regulations are also an important determinant of industrial performance. Evidence suggests that States, which have enacted more pro-worker regulations, have lost out on industrial production in general. (DEA, 2006, p. 209)
The ‘evidence’ referred to above is the seminal work undertaken by two British Economists Timothy Besley and Robin Burgess (hereinafter called BB). In their 2004 paper, they adopted a novel approach, constructing an index of labour law reform (hereinafter called BB Index) by studying the interstate variations in the Industrial Disputes Act (IDA) for the period from 1949 to 1990 and evaluated their impact on manufacturing employment and output. Their study broadly concluded that states with pro-employer tilt in labour laws benefitted significantly, causing considerable excitement among the policymakers.
While subsequent literature has pointed out several limitations of the BB Index, this article has a lingering impact on policymakers in India. The recent moves by several state governments to suspend labour laws during the present pandemic to revive the economy are also a reflection of this influence. There is also great expectation from the recent consolidation of labour laws into four functionally arranged Codes. In this backdrop, this article makes a critical evaluation of the BB Index, and proposes a more comprehensive regulatory measure, which will be useful in testing the relationship between labour regulations and manufacturing sector performance.
Rest of the article is organised as follows: the existing evidence on the relationship between labour regulations and manufacturing sector performance in India is summed up in the second section. The third section discusses the limitations of BB Index. The fourth section briefly mentions the developments after publication of Besley–Burgess paper. The fifth section develops a comprehensive Index and elaborates how it is an improvement over the BB Index. The sixth section concludes the article.
There is a rich and growing body of literature over the past quarter century on the impact of labour regulation on manufacturing sector outcomes. Two different strands are evident within this diverse literature. The first strand, pioneered by Fallon and Lucas (1993), examined the impact of two major amendments in the IDA at the central level in 1976 and 1982 (effective August 1984) on manufacturing employment at the national or industry level, by treating these amendments as ‘structural breaks’. The second approach pioneered by Besley and Burgess (2004) exploited state-level variations in IDA to explain state-level economic outcomes.
The 1976 amendment inserted a new chapter in the IDA (Chapter VB) on special provisions relating to lay-offs, retrenchment in and closure of certain establishments (employing not less than 300 workmen). In particular, Sections 25(M) and 25(N) stipulated that no workmen can be laid off or retrenched without appropriate compensation and prior permission of the competent authority, and Section 25(O) mandated that no industrial establishments employing more than 300 workmen can be closed down without previous permission of the competent authority. The 1984 amendment extended the said provisions to all Industrial establishments with 100 or more workers.
Fallon and Lukas concluded that the said amendment in IDA caused a decline in employment in most industries, averaging 17.5% across industries. Sharpest fall was observed in private sector establishments, employing more than 300 workers. The result was obtained from Census sector of Annual Survey of Industries (ASI) (covering plants with at least 100 workers). No such trade off was observed for sample sector (firms employing less than 100 workers).
However, these results have been questioned. Bhalotra (1998, p. 7) pointed out that the negative relationship in 25 out of 35 industries was found only at the 25% level of significance. At a more conventional 5% level of significance, only 11 industries displayed employment decline. While estimating her own labour demand function based on a 1979–1987 series, she concluded that 1984 amendment cannot explain immediate fall in manufacturing employment in the period from 1984 to 1988 as adjustment of employment to regulatory change had been sluggish. She estimated (Bhalotra, 1998, p. 18) that it took 5.8 years to complete all adjustments of employment to exogenous shocks. Bhalotra also pointed out that compliance with labour laws had been poor, and manufacturing wages were mostly negatively related to regional unemployment during the decade. This should not have been the case if the 1984 amendment had a significant effect, as that would have reduced the threat of retrenchment.
Dutta Roy (2004), after testing for the impact of IDA amendments for the period from 1960 to 1995, concluded that most industries exhibited rigidities in their employment adjustment even before 1976, and only in cement industries, it got worse post the 1984 amendment. In fact, in four industries, flexibility seemed to have increased, which she attributes to increasing recourse to contract labour.
Bhattacharjea (2006) pointed out that both 1976 and 1984 amendments faced several legal challenges lasting next quarter century. Section 25(O) was struck down by the Supreme Court (SC) in 1978. Several high courts passed conflicting judgements on Section 25(M) and 25(N). Finally, the SC upheld Section 25(N) in 1992 and Section 25(M) in 1994. The 1984 amendment, apart from extending the applicability of the aforesaid special provisions to industrial establishments employing 100 workmen or more, also amended Section 25(O) to make it compliant to the directions of the SC. This amended 25(O) was upheld by the SC only in 2002 after it was invalidated by several high courts. Consequently, these amendments became effective at different points in time in different states. Therefore, Bhattacharya argues that the 1976 and 1984 amendments in the IDA cannot be treated as structural breaks. Besides, the 1982 amendment had also altered the definition of ‘Retrenchment’, excluding termination due to non-renewal of contract. This would have provided greater flexibility to employers, thus making it incorrect to classify 1984 Amendment in IDA solely as a ‘pro-worker’ amendment.
The second approach, pioneered by BB (2004), focused on state-level variability in the IDA. They mapped a total of 113 state-level amendments for the period from 1949 to 1990 and classified them as pro-worker, neutral and pro-employer. Pro-worker amendments were given a score of +1, neutral amendments 0 and pro-employer amendments (−1). The scores are cumulated over the years to construct a measure or regulatory reform (called Besley–Burgess or BB Index). When more than one amendment is undertaken in a single year, the concerned state was given a score of +1, 0 or −1 based on the cumulative score of all amendments in the said year. States are classified as pro-worker, Control (no direction) or pro employer based on the overall score. 1 This index is used with several control variables to explain (with a 1-year lag) State-wise outcomes pertaining to the manufacturing sector, such as output per capita, employment, intensity of labour usage, fixed capital, etc. They found a significant negative effect on registered manufacturing output, but they found an opposite sign for unregistered manufacturing. They concluded that high level of pro-worker regulations seemed to deter formal registration, encouraging firms to remain in the informal sector. States with more pro-worker legislations have lower level of employment in registered manufacturing, which parallels findings on output. Number of registered manufacturing factories and value added per employee were both found negatively related to pro-worker regulations. Collectively, these results point to a consistent picture across the board: pro-worker labour regulations are negatively correlated with poor economic performance in the registered manufacturing sector.
These results are broadly consistent with their theoretical priors, according to which there are two mechanisms through which labour regulations can affect economic performance: relative price effect and expropriation effect (Besley & Burgess, 2004, pp. 101–102). Labour regulations raise the fixed or marginal cost of employing labour, as well as the compliance cost through myriad regulatory requirements. Therefore, in a more regulated state, employers are expected to substitute labour with labour-saving inputs. This may also lower firm’s optimal level of output by raising marginal cost of production. Since labour regulations apply only to registered manufacturing, stringent regulations may perversely incentivise firms to remain small so as to escape registration—even forgoing scale economy and efficiency gain. Expropriation effect results from the enhanced bargaining power of labour unions, enabling workers to expropriate part of the return when the capital is already sunk.
From a welfare perspective, it is an open question whether the workers would benefit from greater pro-worker regulations. If labour costs rise because firms are required to adopt more worker-friendly practices, the net impact would depend on whether these are provided for through higher prices, lower wages or lower employment.
Drawbacks of BB Index
The Besley–Burgess paper is a landmark paper, the first to capture state-level variations in an important Labour Act and study their impact on manufacturing output and employment. But subsequent literature has highlighted several limitations of BB Index.
First and foremost, the Index was constructed on the basis of amendments in a single labour legislation (IDA). India’s complicated labour law ecosystem comprises more than 40 central Acts. While mapping state-level amendments in all those Acts is not practicable, certainly, an Index constructed on the basis of amendments in four or five most important labour laws would be a better indicator of a state’s labour law environment.
A second drawback of BB Index is misclassification of amendments. Based on the study of unpublished Annexure of IDA Amendments (London School of Economics [LSE], 2004), Bhattacharjea (2006, pp. 12–13) highlights several instances of misclassification of amendments. This includes the 1968 amendment by Andhra Pradesh, declaring hospitals and dispensaries as public utilities, which although classified as ‘pro-employer’ is, in fact, irrelevant for the manufacturing sector. Similarly, the 1982 amendment, granting Labour Courts the power of a Civil Court to execute its award, is a neutral amendment, though misclassified as ‘pro-employer’ (this, in fact, was a 1987 amendment). Further, 1982 amendments by Madhya Pradesh in Section 7, Section 11 A to 11 D and Section 34 are all neutral amendments, 2 but they were classified as pro-employer. Maharashtra, Odisha and Rajasthan had amended Section 25K of IDA in 1981, 1983 and 1984, respectively, to extend the applicability of prior permission for lay-off, retrenchment and closure to industrial establishments, employing 100 workers or more. These were pro-worker amendments no doubt, but the 1984 central amendment in IDA to reduce the said threshold to 100 workers meant that those amendments had an impact for a very limited duration.
Third, the principle adopted for BB Index to assign a score of +1 or −1 for years in which a state made more than one amendment is flawed. Apart from collapsing 113 amendments to 19 episodes of legislative changes (Bhattacharjea, 2006, p. 13), it has given rise to several inconsistencies. For instance, Andhra Pradesh made eight changes to the IDA in 1987; six of which were assigned a score of +1 and remaining two a score of −1. But the state got a score of +1 only. If the state had undertaken these amendments in separate years, the net score would have been +4, and it could have changed Andhra Pradesh’s classification from pro-employer to pro-worker. Similarly, Odisha carried out two amendments in the same direction in 1983, but the state was assigned a score of +1. But Maharashtra had undertaken the same two amendments in 1981 and 1983, getting a score of +2 for them. Rajasthan’s 1960 amendment was a package of five amendments in disparate directions, yet the state was assigned a score of −1.
Fourth, Bhattacharjea (2006) points out that a state can be classified as pro-worker or pro-employer on the basis of just one or two amendments at any time in the 50-year period. A case in point is Gujarat, which was classified as ‘pro-worker’ based on a solitary minor amendment in 1973— a ₹50 penalty per day on employers not nominating representative to firm-level joint management.
Another flaw of BB Index is non-consideration of state Acts. Uttar Pradesh has its own IDA, which they had amended in 1983 to set the threshold for prior permission for retrenchment at 300 workers in an establishment. Since this amendment received presidential assent after the 1982 amendment in central IDA, the state Act prevails. BB classified Uttar Pradesh as ‘neutral’ because they had not amended the central IDA. But they did not need to as their own state Act was more ‘pro-employer’ than the central Act (Bhattacharjea, 2006, p. 15).
Summary of Subsequent Literature
Criticism of this article has prompted a series of refinements, such as Sanyal and Menon (2005), Ahsan and Pagés (2007), Aghion et al. (2008), etc. These studies by and large validate the basic conclusion of BB, that is, pro-worker labour regulations are generally associated with poor economic outcomes. Ahluwalia et al. (2018) and Karak and Basu (2019) have proposed alternative frameworks to test the hypothesis. Karak and Basu (2019), using a more direct measure of the climate of industrial relations, that is, total number of man-days lost to all industrial disputes, conclude that intrinsic profitability of industries is a more important determinant of inter-state variations in manufacturing sector performance than labour regulations. While the afore-cited papers follow evidence-based approach, a theoretical framework on the desirability of labour market reforms in developing countries, like India, is provided by Chaudhuri (2006). Using a three sector Harris–Todaro model with agricultural dualism and a non-traded final commodity, he concludes that labour market reform is likely to be welfare-improving and may not exacerbate the problem of urban unemployment.
Several authors have also refined BB’s regulatory measure or proposed their own measure, but, so far, there has been no attempt to construct a dynamic and wider measure of interstate variability by addressing the documented deficiencies of BB Index. None has provided a more comprehensive critique of BB Index than Bhattacharjea (2006), but his own regulatory measure (Bhattacharjea, 2009) solely focused on Chapter VB amendments of IDA. Organisation for Economic Co-operation and Development (OECD’s) state labour reform index (2007) is wider in scope and covers amendments in Factories Act, Trade Unions Act and Contract Labour Act. But their measure is not dynamic and is not suitable for panel data analysis over a long period. The regulatory measure of Gupta et al. (2009) is also a refinement of BB index by combining the elements from the OECD (2007) and Bhattacharjea’s regulatory measures. Karak and Basu (2019) suggest a more direct method of industrial relations climate—total number of man-days lost to all industrial disputes. While suitable for panel data analysis, this comes with a health warning about the possible reverse causality between industrial performance and industrial disputes. Therefore, there is, indeed, a need for a more comprehensive measure of interstate variability of labour regulations. This is proposed in the next section.
Towards a New Comprehensive Index
This section seeks to build a more comprehensive and dynamic regulatory measure, devoid of the documented shortcomings of BB Index, with the objective to further analyse the relationship between labour regulations and manufacturing sector performance.
For building a new Index, state-level amendments in five major labour legislations, that is, Industrial Disputes Act, 1947 (IDA); Factories Act, 1948; Industrial Employment (Standing Orders) Act, 1946 (IE(SO) Act); Trade Unions Act, 1926; and Contract Labour (Regulation and Abolition) Act, 1970 (CL(R&A) Act), have been studied and mapped for the 70-year period from 1947 to 2017. A total of 313 state-level amendments 3 in the said 5 Acts across 19 states have been mapped (Table 2). IDA, is the most frequently amended labour legislation (181 times), followed by IE(SO) Act (61 times). Factories Act, 1948, and Trade Unions Act, 1926, were amended 27 times each and CL(R&A) Act 17 times. Among the states, Maharashtra has been the most active, carrying out as many as 55 amendments, closely followed by West Bengal (44). Six other states have amended the aforesaid 5 Acts 20 or more times, that is, Rajasthan (36), Tamil Nadu (34), Madhya Pradesh (31), Andhra Pradesh (28), Gujarat (27) and Karnataka (21).
Summary of Amendments in Five Labour Legislations (1947–2017).
Summary of Amendments in Five Labour Legislations (1947–2017).
has been carried out for years in which there had been multiple amendments. This is because if the same amendments were carried out in different years by another state, their scores would have been different. In order to address this, every change in the labour law has been separately coded, but no adding up has been carried out for multiple amendments undertaken in a year.
For IDA amendments up to 1990, the coding and classifications of BB have been broadly followed, but several misclassifications in BB Index, as discussed in the previous section, have been corrected. In particular, there have been two major departures. First, Bhattacharjea (2009) rightly points out that 1976 and 1984 amendments in the central IDA became effective in different states at different points in time due to judicial interventions, as well as states’ own curative legislative measures (Annexure 2). This has clear implications for interstate variability in regulatory climate, but it was overlooked by BB. This interstate variability in the enforceability of the Act has been explicitly incorporated in the new Index.
Second, the BB Index also ignored state-level labour legislations. The proposed Index has incorporated the impacts of two important state Acts, Madhya Pradesh Industrial Employment (Standing Orders) Act, 1960, and the U.P. Industrial Disputes Act, 1947. The Madhya Pradesh Act is applicable to industrial establishments employing more than 20 workers, as against the threshold of 100 workers under the central Act. The UP Act, effective from 1983, made the special provisions relating to downsizing (similar to Chapter VB of Central Act) applicable to establishments employing 300 or more workers, instead of 100 workers under the central IDA. The first was a significant pro-worker step, whereas the second a very important pro-employer decision. In addition, six IDA amendments undertaken by Maharashtra in 1972, not part of the BB Index, have also been included. While it is not possible to include all 313 amendments in the article, an illustrative list of important amendments is presented in Annexure 3. The new index proposed is in Annexure 4.
Thus, the new Index is not only more comprehensive, it is also free from procedural inconsistencies. While the BB Index is based on the amendments in a single-labour legislation (IDA) over 45 years, this Index has been constructed after mapping state-level amendments in five important labour legislations (including IDA) over seven decades. As against 113 amendments mapped in the BB Index, the proposed index is based on coding of 313 amendments. It is, therefore, a better reflection of labour law ecosystems at the state level and more aptly captures variations across states. However, the basic philosophy is borrowed from BB Index, and in acknowledgement of this intellectual debt, I call it ‘modified BB Index’.
Snapshot of Amendments by Eight Major States.
Figure 1 describes the decadal distribution of labour law regulations and share of pro-worker and pro-employer amendments in them.
Comparison with BB Index.
Because of the different methodologies adopted in aggregating scores, the state scores are expected to vary, but more important is the classification of the states. The major divergence is with respect to Andhra Pradesh, the most pronounced pro-employer state under the BB Index. But mapping of amendments in other labour laws and a more consistent methodology in aggregating the scores have reversed their classification to ‘pro-worker’ as of 1990. However, over the longer time horizon, the direction of labour law reform in Andhra Pradesh turned pro-employer. Gujarat’s ‘pro-worker’ classification baffled many. The modified BB Index classifies them as ‘neutral’ in 1990, though it decidedly turned pro-employer in the first two decades of the current century. Kerala’s classification as ‘pro-employer’ in the original BB Index too was surprising, given its political history, but it retains the same classification under the modified Index.
The cumulative scores of eight states, that account for 90% of all amendments, are plotted in Figure 2, as per both BB Index and the modified Index. Six of these states, with the exception of West Bengal and Tamil Nadu, have turned distinctly ‘pro-employer’ during the first two decades of the current millennium. West Bengal’s labour law ecosystem has retained its pro-worker character throughout the period up to 2017. Tamil Nadu is the only state that has moved from ‘pro-employer’ to ‘pro-worker’ direction during the first two decades of 2000, albeit slightly.
The modified BB Index will be helpful in studying the relationship between labour regulations and output, employment, etc., in post-economic reform period, which has remained under-investigated. During this period, particularly the years following publication of BB paper, several states have amended labour law regulations in pro-employer directions. But the Index itself and the econometric methodologies of BB have come under considerable criticism. Therefore, it is of interest to study the relationship between state-level variations in the labour law and manufacturing sector performance in the subsequent priod. This new Index will be helpful in estimating the impact of labour law reforms on the manufacturing sector performance post-economic liberalisation. Besides, the modified index also provides an opportunity to retest the Besley–Bugess results for the period from 1947 to 1997 against the modified state classification and scores, and to see whether the original results hold. All these will provide valuable policy guidance, particularly at a time when India’s labour law ecosystem is being overhauled through their consolidation into four functionally arranged Codes. This Index can also be extended easily by another researcher in future to study the impact of the said consolidation.
Status of 44 Labour-Related Central Acts After the Four Codes Become Effective.
The 1976 amendment in the IDA faced immediate judicial challenge. Section 25O (regarding closure) was struck down by the Supreme Court (SC) in the Excel wear case, as it was interpreted as imposing unreasonable restrictions on the right to carry out business. The 1982 amendment (effective 1984) introduced several procedural amendments in Section 25O to satisfy the SC. Four states passed curative amendments in the meantime: Maharashtra (October, 1981), Odisha (February, 1983), Madhya Pradesh (October, 1983) and Rajasthan (April, 1984), making this Section effective in their respective states at an earlier date.
On the other hand, Karnataka and Calcutta high courts struck down the amended Section 25O in 1985 and 1988, respectively. A division bench of Karnataka High Court reversed the earlier decision in 1988, implying that the Section remained inoperative for the intermediate time. Allahabad HC also struck down Section 6(W) of state IDA (corresponding to Section 25O). In West Bengal and Uttar Pradesh, the Section became operative only in 2002 when SC validated the section.
In addition, Section 25N (regarding retrenchment) was struck down by Madras High Court in March, 1980, and the Section remained inoperative in Tamil Nadu till the 1984 central amendment.
The net effect of the above is that Chapter VB amendments became effective in different states at different points in time.
Illustrative List of Important State Amendments in Central Labour Acts.
Proposed Regulatory Measure on Interstate Variability in Labour Laws.
Supplemental Material
Supplemental material for this article is available online.
Supplemental Material for Towards a Comprehensive Index of Labour Law Reform and Ranking of States by Bhaskar Dasgupta, in Arthaniti: Journal of Economic Theory and Practice
Footnotes
Acknowledgement
The author is thankful to an anonymous Referee for his/her thoughtful comments on an earlier version of this article. Thanks are also due to author’s PhD supervisor Dr. Sukanta Bhattacharya of University of Calcutta for his guidance. Needless to say that any error remaining is entirely the responsibility of the author alone. The author is a civil servant, but the views expressed in the article are his own and not that of the Government of India.
Declaration of Conflicting Interests
The author declared no potential conflicts of interest with respect to the research, authorship and/or publication of this article.
Funding
The author received no financial support for the research, authorship and/or publication of this article.
Notes
References
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