First published: Monday, 27 June 2005

There is a story of a prospective school teacher who was asked during an interview by the principal of a conservative religious school, "Is the earth flat or round?"

The hapless teacher looked around at the faces of the interviewers for hints and, not finding any, settled for: "I can teach it flat or round." 

The trouble with a lot of our economic policy advisers is that they are like the school teacher.

They try to gauge what answers will make them popular with their political bosses and then give them the advice they seek.

This may be good for the advancement of their career but is not good for economics or for the country in question.

One area where modern economics has a lot to offer, but what it has to say is not pleasing to the ear, is labour regulation.

In India today, this is the most important area crying out for reform.

An injection of flexibility in labour market regulation can attract foreign capital, create jobs and unleash higher growth.

But reforming labour laws is no easy task.

Chaotic laws

This is one area where what appears to be good is often not so. 

The body of legislation that shapes the industrial and labour environment in India is huge.

Here is a minuscule sampler: Minimum Wages Act, 1948; Trade Unions Act, 1926; Contract Labour Act, 1970; Weekly Holidays Act, 1942; Beedi and Cigar Workers Act, 1966.

These and much more form a crisscrossing network of chaotic, strangulating, overlapping and often-contradictory laws that are crying out for overhaul.

The single most important labour law is arguably the Industrial Disputes Act (IDA), 1947.

This was enacted a few months before India's independence and guides the hiring and firing rules of the industrial sector and is a good example of a well-meaning policy that is founded on antiquated economics and a handsome misunderstanding of the way markets function.

The IDA makes it very hard for firms to fire workers.

In fact an amendment made to the IDA in the mid-1980s requires that any firm employing more than 100 workers needs to get permission from the state government before retrenching workers (and in practice that permission is seldom given).

This law has probably done more to hold back the growth of India's manufacturing sector than any other policy.

What is remarkable about this and so many other Indian labour laws is that they leave no room for free contracting. 

Suppose a firm wants to manufacture a product that has volatile demand - like fashion garments.

This firm may want to offer workers higher wages but make it clear to them that they could be given a month's notice and asked to leave.

Such a contract will have no legal standing because the IDA specifies in advance how and when workers may and or may not be retrenched. Hence we do not see such contracts. 

At first sight this law looks like a kind piece of legislation that protects the jobs of poor workers.

Non viable

What this popular view misses out on is the fact that this law also keeps hundreds of thousands of workers unemployed because firms, wary of the fact that they will not be able to offload them, do not hire in the first place.

Also, in areas of volatile demand, many firms have not even come into existence because they realise that India's current legal regime makes them non viable.

It is not surprising at all that labour data from the '80s show that the number of people employed in firms of size greater than 100 workers has gone down.

This is the market's natural response to the amendment in the mid-'80s.

What is needed is not freedom to firms to wantonly fire workers but a legal regime whereby firms can write different kinds of contracts with their workers depending on their needs.

One firm may offer a low wage and life-time guarantee of work and another a high wage and very short notice to quit.

Rigid

Some recent data compiled by the World Bank collate the level of rigidity of hiring and firing rules in different nations -100 being the score of the highest conceivable rigidity. 

India is among the most rigid countries with a score of 48.

China has a score of 30, Korea 34, Norway 30; Singapore close to 0.

The fact that the less rigid nations also have more efficient economies, higher wages and a smaller share of labourers who are long-term unemployed may not be entirely a matter of coincidence.

Given that the reform of labour laws is, contrary to popular perception, in the interests of the workers, what government needs to do is have this topic debated and explained so that workers, instead of opposing such reform, become its advocate.

The reform will need a substantial amount of intellectual input and will need complimentary policies for providing social security and welfare to workers. 

But if this government can achieve a major rationalisation of India's labour laws, it will leave behind a legacy for many future generations.

 Dr. Kaushik Basu, Professor of Economics and Carl Marks Professor of International Studies at Cornell University

This article first appeared on the BBC News Column published in Monday, 27 June 2005.