In its urgency to bring in foreign investments to encourage future growth and employment, govt must remember that timing is as critical as the content of reforms
Amidst the raging Covid-19 pandemic, structural policy changes to the labour market were announced last week. Four state governments—Uttar Pradesh, Madhya Pradesh, Gujarat, and Assam—set aside many legal regulations for a temporary period. Both, the proposed removal of many legal restrictions and the period of pause, vary across the states. The context, too, is set by the virus outbreak: To attract investments, notably foreign companies looking to relocate elsewhere from China in the aftermath of Covid-19. Such fundamental changes for a more flexible labour market are important, necessary steps to attract such investments, and build a large-scale manufacturing base for creation of mass employment. The reforms are welcome. However, in the desperation not to ‘miss the manufacturing bus’ this time at least, the reforms are more a ‘caricature’. They lack uniformity, permanence, and good timing. The government should think more deeply and carefully about these issues. Panic reforms that are poorly timed and differentiated can be counterproductive, as recent structural reform experiences show. They run the risk of being reversed.
The determined effort to woo companies to shift to India over past favourites such as Vietnam, amongst others, is creditable. India has long struggled to achieve a strong large-scale manufacturing foundation for want of such fundamental changes to its labour markets that have now suddenly come about. These have long eluded India, no matter the colour of successive governments. The longstanding deficit in mass-job creation potential has withheld absorption of surplus labour that disengages from agriculture, which reduces one percentage point share in aggregate output every year. As a result, livelihood dependence upon agriculture has increased; a relatively small proportion of the labour force shifts to low productivity services. So, if there is an opportunity, especially when Covid-19 has wrought serious output losses that threaten India’s medium-term potential, the government is rightfully trying to provide fresh economic impulse through structural policies, which should yield long-term benefits to employment and growth.
But, there are serious drawbacks regarding consistency and permanence. The restrictions lifted temporarily are different in each state, with some distinctions in new and existing businesses. For instance, UP scrapped all labour laws except four (preserving laws for accident compensation, construction employment, bonded labour, timely wage payments, children and women). Gujarat said no labour law will apply to all new firms that wish to, and existing firms that operate there; it retains minimum wages, safety, and accident compensation laws. MP plans massive exemptions to new manufacturing units from most provisions of the Factories Act, 1948, freeing safety and health norms, and the design of service conditions. Assam proposed to bring in fixed-term employment, and take more firms out of legal coverage of factories and contract workers.
So, for example, a company hypothetically sets up a manufacturing unit in UP but has a subsidiary in another state, it will face a different legal environment! How would an investor view this? It is unthought-of that labour market reforms, coming after so long, become a deliberated creation of different legal regimes across the country. It is more ludicrous that this differentiation is being planned when a completely reverse objective—an integrated national market—drove the indirect tax system reform for its harmonisation three years ago!
Two, the period for which these restrictions are relaxed also varies from three years (UP) to 1,200 days (Gujarat) and 1,000 days (MP). How does a prospective investor-entrepreneur view this when the set-up and construction phase of a new manufacturing plant itself is that long? The manufacturers require flexibility precisely when the plant commences, i.e., in the operational phase, to safeguard against business cycle fluctuations when they might need to prune down or exit altogether! This is basic economics. What is needed to convince investors, and of course for improving efficiency, is permanent change that fundamentally alters deep-rooted patterns in the functioning of the Indian labour market. This does not happen if restrictions are quickly set aside for 2-3 years! How do you convince an outside investor about continuity, knowing full well that India is a democracy? And, with a rich history of retrospective policy and regulatory changes that were well described by Swaminathan Aiyar in a recent article!
These reforms are a non-starter. Structural reform policies endeavour to change the working of an economy in a more fundamental way, which India requires. Even pre-Covid growth had slid to lower levels and was languishing there; now, there is further threat the pandemic will cause structural damage to potential output and productivity in the medium-term. Increasing the long-run growth potential with structural breakthroughs is important. But, such structural reforms require careful thinking and proper design, and cannot be carried out in desperation and anxiety to catch the manufacturing bus. Otherwise, they can be counterproductive.
The reforms are also not well timed: They come amidst a serious humanitarian crisis—a large-scale, prolonged exodus of migrant workers from their cities of work to their permanent homes in the worst of circumstances. Time will tell if their experience has permanently, or to some extent, destroyed or eroded trust and confidence in the state. Because the reforms remove established norms and practices, there is a risk of reversal. Just as the arguments for wide-spread economic benefits are very powerful, so may be the opposition at such a time.
Recent experiences establish how counterproductive structural reforms can be if not carefully designed and well-timed. For example, the goods and services taxation reform has failed to deliver the expected efficiency and revenue gains, precisely because of these reasons. GST reform was instituted in July 2017, barely six months after the adverse demonetisation shock, i.e., wrong timing. Since then, there have been constant revisions and changes to its design, formats, fulfilment requirements, rates, and so on. Two years later, this has still not stabilised, commonly regarded a failure, and more seriously, is perceived to have hurt the MSME segment.
The Insolvency and Bankruptcy Code (IBC) was expected to be the answer to all prayers of bad assets’ resolution, restore banks’ and corporates’ health, and enable a fresh start to the private investment cycle. However, IBC is all but dead in spirit from constant changes, legal tangles and battles, the accompanying responses of all concerned parties to step outside the framework and get on with life by getting back to business-as-usual! Bad asset resolution is still an unaccomplished task five years after the first step towards it—asset quality review—was taken. The economic fallout of this is not insignificant.
The government’s urgency to bring in foreign investments to encourage future growth and employment is entirely understandable. But, in the desperation and nervousness about the enormous devastation caused by Covid-19, it must not reform in a panic. For it runs the risk of losing sight of the larger, long-run picture of lasting reforms that are productive and irreversible. It should guard against the risks of these becoming counterproductive, and dangers of reversal.
The writer is New Delhi-based macroeconomist. Views are personal