Published on Jobs and Development

Indian labor regulations take small steps in the right direction

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There have recently been some important changes to India’s labor regulations. These are small steps in the right direction as the country tries to reduce the number of informal workers. These changes include Rajasthan’s recent amendment that raises the threshold for seeking state government permission for retrenching or laying off workers from 100 to 300 workers. Rajasthan has also increased the threshold employment for stipulations on work hours, work days and minimum age requirements under the Factories Act. And they have raised the minimum membership for the registration of a representative union from 15% of the firm’s employment to 30%. 

In addition, in a movement away from the Inspector Raj, the central government has set up a unified web portal where firms can themselves file their compliance reports pertaining to 16 central labor acts.  Such a web portal is expected to have a built-in algorithm that will select firms that need to be inspected. Hopefully, this is just the beginning and we will see more reforms in the future.

But why is this so important for India? Developing countries tend to have a large proportion of their employment in the informal sector. In India it is especially high. For instance, the informal percentage of employment in non-agricultural employment is 83.6%. The proportion of informal employment in the manufacturing sector is 87% (ILO, 2012).  If you use per capita GDP as a predictor and compare India with other countries, India’s predicted informal employment as a percentage of non-agricultural employment should be a little above 60% (ILO, 2012). This means that, given its level of development, the actual proportion of informal employment in India is about 40% higher than it should be. For India to reach that level of 60%, the formal sector would need to more than double in size.

Another way to look at this is by comparing correlations between poverty and informal employment. About 28% of the Indian population is below the national poverty line. Brazil, Uruguay and Costa Rica have poverty rates close to that number. However, their share of informal employment in nonagricultural employment is around 40%. In Uganda, where the poverty rate is also roughly 28%, the share of informal employment stands at around 70%.

India-China comparisons are always interesting - even though China’s per capita income is much higher and its poverty rate much lower. Here we can see that China’s informal non-agricultural employment share is only 32.6%.  

Why is India’s informal sector so large? Here it is extremely important to note that most of India’s labor regulations apply only to the formal sector and to formal workers. The large informal sector is most likely a response to these regulations.

In the World Bank (2006) Doing Business survey, India and Mexico are the only two countries that answer in the affirmative to six of the seven questions on the existence of rules governing redundancy dismissals and layoffs. In addition, only India, Indonesia, Mexico and Sri Lanka require third party approval for dismissals. Thus, India’s labor regulations are probably among the most restrictive in the world.  

There are 200 labor laws in India, including 52 Central Acts. Probably, the three most restrictive acts are the Industrial Disputes Act (IDA), the Industrial Employment (Standing Orders) Act and the Trade Union Act. The IDA requires firms with more than 100 workers to seek permission from their respective state governments for retrenchment or laying off of workers. This is seldom granted. The Industrial Employment (Standing Orders) Act requires such firms to ask for permission even for modifications in job descriptions. The Trade Union Act lets any seven workers within a firm form a union, which leads to multiple labor unions. In addition, this act provides each such union the right to strike and to represent workers in legal disputes with employers.

It is important to look at the data on the impact these laws have on overall employment, the average quality of jobs and exports of labor-intensive manufactures. Several empirical studies have looked at variation in labor laws and their implementation across Indian states, which have arisen from state-level amendments. The following are some important findings regarding the impact of labor regulations.
  • Besley and Burgess (2004) find that state-level formal manufacturing output, investment, employment and productivity in India declined with restrictive or rigid labor regulations. The corresponding aggregates for informal manufacturing increased.
  • Hasan, Gupta and Kumar (2009) find that Indian states with relatively restrictive labor regulations have experienced slower growth of labor-intensive industries and overall employment than others.
  • Dougherty, Frisancho Robles and Krishna (2014) show that productivity in Indian firms in labor-intensive industries as well as in industries facing highly volatile demand was, on average, about 11%-14% higher in the states with less restrictive labor laws than in others.
  • Hasan, Mitra and Sundaram (2013) find that India uses more capital-intensive techniques of production than predicted by its level of development and than those used by China in many industries including paper and printing, leather, rubber and plastics, chemicals, non-metallic minerals, base metals, metal products, electrical equipment and instruments and petroleum.
Thus we see that India’s outdated labor regulations have restricted formal nonagricultural employment. The recent initial steps towards reforming labor laws, though in the right direction, form just a tiny fraction of what needs to be done. The blocking of further progress in labor reforms by recent labor union protests is, therefore, somewhat concerning.


Devashish Mitra

Professor of Economics at the Maxwell School, Syracuse University

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