The Indian Economy Blog

August 1, 2006

Hard To Fire Is Hard To Hire

Filed under: Business — Nitin @ 3:44 pm

The World Bank’s Doing Business report drives home the need for labour reforms

According to World Bank’s new Ease of Doing Business league table (linkthanks Debashish), it was easier to do business in Maldives (#31), Nepal (#55), Pakistan (#60), Sri Lanka (#65), Russia (#79), China (#91), Bhutan (#104) and even Iran (#108), than in India. In fact at number 116, it was slightly more difficult to do business in India, than in war-torn Iraq.

The international ranking reveals how India is doing in comparison to other countries. But how has India own performance changed? There are 23 parameters that are common between the latest report, released in 2006, and the previous one released in 2005 (both are based on data compiled two years before publication). Of these, India has improved its score in 10 and slipped in 5 areas. None more so than in the area of hiring and firing workers.

It became more difficult to hire and maintain workers in 2004 as compared to the previous year. There was no change in the difficulty to fire, but at 90 out of 100, India is already one of the hardest countries in the world to fire workers.

Starting a business continues to involve 11 separate procedures; but in 2004, it took 71 days to do so, as compared to 89 days the previous year. That didn’t come without an increase in the cost of starting a business which rose to 62% of per capita in income in 2004 from 49.5% the previous year.

It also takes 10 years to close a business.

The upshot of all this? Exit barriers are also entry barriers. Making it hard to fire workers only ends up making employers unwilling to hire them and investors unwilling to invest in manufacturing (read job creating) industries. Miss the simple truth and you can have endless academic and political debates about why India’s decade and half of economic growth has been a jobless one.

26 Comments »

  1. We should not assume the politicians do not know this. We then have to understand why they do not act on this if they already know this.

    The answer is that there has to be a period where the unemployment would actually increase. Starting a firm is not an instantaneous process, and additionally there are many other regulations which make starting and operating a firm in India difficult.

    Essentially, the microeconomics — which drives the political cart — militates against long-term macroeconomics.

    I lay the fault not on the politicians but on the economists who refuse to acknowledge this and suggest suitable solutions.
    One of which is of course graduated labor reforms, another is to identify a package of relaxing other job creation bottlenecks so that a relaxation in labor laws does not increase unemployment in the short term.

    Comment by seven_times_six — August 1, 2006 @ 6:11 pm

  2. As this is a World bank publication, i wouldnt be too interested.
    But economists need to uphold the welfare of the labouresrs and it is important that
    labourers have security.
    India inc has been showing good returns and investors confidence has increased.
    Its absurd to believe that it would be better to start a business in iraq than in India.

    Comment by Alex — August 1, 2006 @ 10:52 pm

  3. “As this is a World bank publication, i wouldnt be too interested.”

    Why? You are free to do what you want but this attitude is odd.

    “But economists need to uphold the welfare of the labouresrs and it is important that
    labourers have security.”

    Economists don’t need to do any such thing. You misunderstand the job of an economist and confuse it with that of a politician. Also: Why is it important that labourers have security?
    You seem to ignore the fact that the consequences of making workers hard to fire are borne by *other* members of the working class. Faced with the fact that it is difficult to fire workers, firms typically optimize by minimizing the number of workers they hire. This tilt towards capital-intensive technologies only hurts other workers who remain unemployed or find it more diffcult finding work.

    “Its absurd to believe that it would be better to start a business in iraq than in India.”

    The issue is about the *ease* of doing business, not the adivisability or the profitability of doing business. Its is perfectly possible that doing business is easier in Iraq than India but its more advisable to do business in India than Iraq.

    Comment by economist — August 2, 2006 @ 12:14 am

  4. seven_times_six, you write:

    “The answer is that there has to be a period where the unemployment would actually increase. Starting a firm is not an instantaneous process, additionally there are many other regulations which make starting and operating a firm in India difficult.”

    Your assertion that there is an initial period where unemployment would increase is just that – an assertion. Do you have anything to back this up?

    Even if this were true – and I don’t think it is – to attribute this as a reason for our stupid policy is to give too much credit to our politicians who typically have not displayed any such skills at such subtle economic reasoning.

    Comment by economist — August 2, 2006 @ 12:55 am

  5. Economist, the burden of proof is on those who say that it won’t cause unemployment.

    Also, note that what’s on the books is to allow firms to fire employees more easily. This suggests a very high plausibility that at least initially, the upshot would be for firms to fire deadweight more than new hirings.
    This is because new hirings necessarily follow from expansions, and expansions do not occur instantaneously.

    Also, your belief that politicians are stupid and economists are brilliant does not help matters at all. As I said in the previous post, the economists have to adapt their policies to make sure that microeconomic fallouts are minimized.
    Otherwise, the labor reforms are never going to take off.

    The economist can then say, hey, it is the fault of the politician, who is doing his job of responding to political pulls arising from potential microeconomic fallouts.
    It is the economist who refuses to do his job of formulating an economic policy given the constraints.

    Comment by seven_times_six — August 2, 2006 @ 5:22 am

  6. Seven_times_six, *you* asserted that it will cause unemployment in the immediate run and the burden of proof is on me?

    I suspect that this is not going to get anywhere. You seem to have a penchant for reading into statements things that were not not even remotely implied. I said the current labour policy is stupid; does this imply that politicians are stupid? Where did you get that from? Also, the statement that economists are “brilliant”? I do think that our politicians implement policies which make little economic sense, but this is not the same as saying that politicians are “stupid.” Politicians have their own objectives to pursue, after all.

    Economic policies do have fallouts – it is the job of the economist to lay out all the possible consequences of a given policy, to the extent possible. It is then the job of the politician to implement the best policy given the political and other institutional constraints. That is what the politician has been elected to do.

    The proposed labour market reforms – if implemented – will only affect the “organized” sector of the economy. Given that this sector employs a fairly small – but vocal – part of the labour force, it is not at all clear that these labour reforms will lead to anything like significant increase in the unemployment rate. This does not mean that *some* workers will not be negatively affected. Things can be done to ease the burden of such workers, but these come into play only if there is political willingness to implement the proposed reforms.

    I look forward to your reading things into what I’ve written which I did not mean, but I will not respond. Feel free to have the last word.

    Comment by economist — August 2, 2006 @ 10:28 am

  7. Dear Economist,
    As far as the World bank report is concerned, what is the need for ranking countries where ease of starting a
    business is more, without including variables such as profitability or security? This ranking should not be
    considered for serious academic discussion.
    For economists, at least for concerned individuals who have a responisbility towards the nation and to other
    fellow citizens, it would be laudable if the labourers’ interests are considered. The duty of an economist can be infinitely argued upon without reaching a conclusion because of differences in ideologies.
    So you are of the opinion that is legal and ethical to hire and fire workers easily so that the unemployed will get jobs.
    There is a glitch there, firms which have the potential of using capital intensive techniques would have long back
    invested in them if they had the necessary resources. Moreover labour is cheap here, so i dont think that, they
    would trade off the cheap labour for costly capital.

    Comment by Alex — August 2, 2006 @ 12:03 pm

  8. Dear Alex:

    We all adopt various hats at various times: sometimes I speak as an economist, sometimes as a concerned citizen and so on. Of course, it is not possible to disentangle the various roles but the point nonetheless remains that I do not think that it is the duty of an economist to “stand up for labour” whatever that might mean.

    I am somewhat puzzled about you. You claim to be studying economics in your blog, yet your arguments are anything but economic. For instance, you seem to think that “labour” means solely those who have jobs. What about the unemployed? Any enlightened labour policy must take into account that the interests of the unemployed also matter. If you make it difficult to fire workers, then any sensible entreprenuer will minimize on the number of workers he hires. This ultimately hurts “labour” because it becomes more difficult for workers to find jobs.

    You come from Kerala: don’t you think that the large expatriate Malayali community in places like Mumbai, the Gulf states etc. has at least something to do with the fact that labour regulations are quite stringent in Kerala as compared to other states?

    We all want to protect workers – certainly I do – and it is not my contention that Indian entrepreneurs are noble-minded, fair etc. They are not. But protecting “labour” means protecting not only the rights of those who have jobs, but it must also encourage entrepreneurs to start new enterprises because these create new jobs. It is in this context that the World Bank report is relevant because it documents that starting new businesses is quite tedious in India.

    Finally, the fact that labour regulation actually hurts economic performance is well documented. See for instance, the paper by Tim Besley and Robin Burgess “Can labour regulation hinder economic performance?: evidence from India” The paper is quite technical, but I append the abstract below:

    “This paper investigates whether the industrial relations climate in
    Indian states has affected the pattern of manufacturing growth in the period 1958-92. We show that states which ammended the Industrial Disputes Act in a pro-worker direction experienced lowered output, employment, investment and productivity in registered or formal manufacturing. In contrast, output in unregistered or informal manufacturing increased. Regulating in a pro-worker direction was also associated with increases in urban poverty. This suggests that attempts to redress the balance of power between capital and labor can end up hurting the poor.”

    The paper is avalaible from Robin Burgess’s homepage at the London School of Economics:

    http://econ.lse.ac.uk/staff/rburgess/wp/

    Comment by economist — August 2, 2006 @ 1:45 pm

  9. Hi all,

    A very interesting debate indeed. The politicians vs economists debate, though exciting, is beside the point though.

    \”Economist\” makes a very valid point. In fact, I wanted to write it in the post, but decided not to do so in order not to digress. That point is that investors have a wider set of considerations before they invest in a market. China, for example, ranks quite low too, but is sucks in a lion\’s share of FDI. So the World Bank numbers are not so important for India\’s attractiveness as an investment destination, but rather, its ability to get its economic policies right, labour reform being one of them.

    Economist—According to Ajay Shah, the labour market itself (informal plus formal) clears. Notwithstanding this, don\’t you think the distinction between formal and informal sectors distorts the labour market?

    Alex — The report uses methodology compiled by reputed economists. So instinctively dismissing it would not be a smart thing to do. Many disagree (eg Atanu Dey, a co-blogger here) that economics is a science in a strict sense, nevertheless, it is just as well that economists approach the subject with a scientific temper.

    As for your point about cheap labour; the cheapness of labour itself won\’t bring in job-creating industries. For that you need efficient labour markets. But you are right that companies may not use capital intensive techniques. Instead they\’ll just set up factories in countries where labour is cheap. In future, even Indian companies will do that just to stay competitive.

    Comment by Nitin — August 2, 2006 @ 3:16 pm

  10. Dear Nitin,

    Re: “Economist—According to Ajay Shah, the labour market itself (informal plus formal) clears. Notwithstanding this, don’t you think the distinction between formal and informal sectors distorts the labour market?”

    I don’t know Ajay Shah’s work in this regard, but the distinction between formal and informal sectors does add distortions to the economy. For instance, some entrepreneuers deliberately choose technologies that enable them to escape coming in to the organized sector. The Besley-Burgess paper referred to above documents such behaviour. (A long time back, I was told that the producer of Nirma had deliberately adopted this strategy; can anyone confirm?)

    From an economic efficiency point of view, such shifts are not desirable because it prevents the firms from exploiting economies of scale. However, these shifts are not desirable even from the point of view of labour because labour norms are much less enforced in the unorganized sector. One would have thought that concern for labour would translate into policies which encourage entrepreneurs to come into the organized sector. The actual policy has had precisely the opposite effect. So much for the “pro-labour” policies.

    Of course, life is much better than it would otherwise have been for those fortunate to find employment in the organized sector, especially our public sector enterprises. The price for this is paid by those who slog it out in the unorganized sector in places like Bhiwadi and so on.

    Comment by economist — August 2, 2006 @ 4:26 pm

  11. Dear economist
    Regarding the ‘standing up for labour’, i meant considering the labour force, both employed and unemployed.
    I agree that the labour policy in India is not conducive for high rates of industrial growth. But i believe
    that the currently employed must be secured of their jobs, otherwise the unemployed would not have any incentive
    to get employed.(In an easy hire and fire policy)The labour problem is a complex issue because people are directly
    involved and a solution cannot be arrived at easily.
    It is easier to start a business in India than Iraq but it is difficult to do business in india than Iraq. I find this amusing. Difficulty in doing business in India:reasons are many-higher costs, uninonised labour,etc. Businesses that are competitive and efficient can easily thrive in the Indian market.
    An article about ‘standing up for labour’ was published in the Economic and political weekly by Martha Chen et all
    titled Informality, gender and poverty.

    Dear Nitin,
    On the issue of reputed economists making the study: I agree. In economics like the demand and price relationship, where other variables are assumed as constant, we cannot conclude that it is difficult to start a business in india.
    The variables they included in the ranking are procedures,time,cost and minimum capital to open a business.
    (I do know know what a business refers to in the context. Could somebody enlighten me?) In india, as the
    corruption is high, it is difficult for small investors to start a business but not so for high investors.

    To all,
    About rankings, I have become averse to them. A magazine, few years earlier reanked a collge as no 1 when it wasnt evn supposed to come in the top 10.

    Comment by Alex — August 2, 2006 @ 5:50 pm

  12. *Sigh* Alex, I have a feeling that this is going to be a futile effort but I will have one shot and then let it go. You can have the last word. You say:

    “But i believe that the currently employed must be secured of their jobs, otherwise the unemployed would not have any incentive
    to get employed.(In an easy hire and fire policy)”

    Really? What are the unemployed going to do? It is not as if India has a great social security scheme which will enable people to get along without employment.

    If you are from a middle-class family (as seems likely), then I think you must have a “servant.” (Note: After moving abroad, I became aware that this term is used only in India!) Does your servant (or those of your acquaintances) have protection against hire-and-fire? Or medical leave? Or any of those perks enjoyed by those of us fortunate to find employment in the organized sector? Then why does he/she work? According to your thinking, it must be terribly difficult finding suitable “servants.” Does anyone in the middle class really have problems finding “servants”?

    Ponder this also: do you think that the majority of the workers in India are in positions similar to our “servants”? Or are the majority in positions similar to those in public sector enterprises or in the organized part of the private sector? You have a strange idea about the composition of our labour force.

    I have great respect for Martha Chen and though I have not read her article, I think given her record that she was writing about conditions in the “informal” sector which are indeed bad, as I’ve noted above. The proposed reforms are targeted at the “organized” sector. The reforms therefore are not in contradiction to what Martha Chen says.

    I am constrained to say this: for someone who claims to be studying to be an economist, I’ve rarely come across less economic arguments than those you make. I am at a loss to account for this.

    Comment by economist — August 2, 2006 @ 6:47 pm

  13. “But i believe
    that the currently employed must be secured of their jobs, otherwise the unemployed would not have any incentive
    to get employed.(In an easy hire and fire policy)The labour problem is a complex issue because people are directly
    involved and a solution cannot be arrived at easily.”

    Really? Is job security in your top three questions when taking a job? If the job were absolutely not secure, would you reject well paying job? If people are involved, it must be complex and difficult.

    “An article about ’standing up for labour’ was published in the Economic and political weekly”

    Ah…the Bhagavad Gita of economics and sensible policy. At least we know where your ideas are coming from.

    “ In economics like the demand and price relationship, where other variables are assumed as constant, we cannot conclude that it is difficult to start a business in india.
    The variables they included in the ranking are procedures,time,cost and minimum capital to open a business.
    (I do know know what a business refers to in the context. Could somebody enlighten me?) In india, as the
    corruption is high, it is difficult for small investors to start a business but not so for high investors.”

    That does this mean? Now we need define what a business is?

    Comment by Chandra — August 2, 2006 @ 9:11 pm

  14. Dear economist,
    I am just a student of Economics and i am prone to mistakes. But i agree to what you have said about our servants
    and i realise that i was mistaken in talking about the incentives.
    Well i am not exactly sure about the composition of our labour force, but i do believe that the unorganised sector
    and organised sector have nearly equal employment opportunities. But the data for informal sector is lacking.

    Comment by Alex — August 2, 2006 @ 9:58 pm

  15. “Well i am not exactly sure about the composition of our labour force, but i do believe that the unorganised sector and organised sector have nearly equal employment opportunities.”

    About 60% of our labour force is still employed in agriculture. The “organized” sector employs only 7-8% of the total workforce. Check out

    http://indiabudget.nic.in/es2004-05/chapt2005/chap105.pdf

    Comment by economist — August 2, 2006 @ 10:45 pm

  16. Dear economist
    Thank for the link. That sure is interesting.
    Could i ask you a personal question? What is your profession?

    Comment by Alex — August 2, 2006 @ 11:50 pm

  17. Sudeep Banerjee is right!

    Comment by sun — August 3, 2006 @ 3:09 am

  18. I would like to clarify on my earlier comment.According to 2001 census,India had as many as 12666377 children(belonging to age group 5 to 14 )
    working in the informal sector.This group is supposed to benefit most by the labor law reforms.Any ways Give them OLPC device and there will be millions
    of tiny bloggers!I apologise for posting off the topic comment.Feel free to delete it

    Comment by sun — August 3, 2006 @ 4:46 am

  19. Economist:

    you state very clearly that politicians are incapable of nuanced economic reasoning and tell me I’m putting words into your mouth about your low reckoning of politicians?
    And what’s with the dramatic “you can have the last word” and all that?

    You must understand that I’m not debating or antagonizing you: I actually want smart free market economists like you to formulate smart solutions that can actually take off the ground.

    Nitin:
    I actually think the argument of politician vs economist is relevant in the sense that I think drawing vanilla policy suggestions from just such studies is unadvisable. No investor worth his salt thinks it is better to do business in Nepal and Bhutan rather than India.

    The study is merely a ranking of labor restrictions, but from which passionate economists from the Milton-Friedmanian school make their naive policy inferences; without taking into account the current microeconomic situation in countries like India: but which have to be taken into account to make any solution politically feasible.

    I detailed some possible solutions in the previous comment (e.g. try to identify other regulation relaxations which would cause expansions and increase job growth and THEN relax labor restrictions. This would ensure the unemployment increase would be kept to a minimum and perhaps it would not increase at all)

    I’m not an economist and I really do not have much info. about the microeconomic situation either, but it has to be possible for our smart economists to hasten our transition to a market economy by doing it intelligently by taking into account microeconomic political feasibility.

    I apologize for the seeming pedanticity, but this is something I’m starting to feel strongly about.

    Comment by seven_times_six — August 3, 2006 @ 10:32 am

  20. Nitin: To clarify what I’m saying in my prev. comment, the danger from such studies is not that investors draw bad conclusions; which you rightly point out in your prev. comment; but that Friedmanian economists draw bad conclusions.
    (Look at even the tagline of your post :)

    As such it is not a politican vs investor but a politican vs economist argument.

    Comment by seven_times_six — August 3, 2006 @ 10:43 am

  21. Alex,

    I am an economist, of course.

    Apologies in case my comments offended you but I was expecting better economic reasoning from you. It’s good that you are passionate about the subject; good luck with your studies.

    seven_times_six, subtle economic reasoning is a skill that does not come naturally to everyone but of course, it can be learned. This is not peculiar to economics – not all have natural skills at maths or physics or any other branch of study. In all honesty, most (not all) of our politicians have not displayed that they are skilled in the type of economic reasoning that you put forward as an explanation of why our politicians have stuck to our current labour policy. This does not imply they are stupid. I would not make the mistake of underestimating any of our politicians; many of them are very smart. I think many of their economic policies are wrong-headed but as I have said, that is a different matter.

    You inferred something that I did not imply but I do not expect you to acknowledge that, given that your opinion of economists is not high. Presumably, the economists are not smart enough to see what you have seen – that economic policies need to be politically viable as well. You have been repeating this point throughout this thread. Yes, of course, people like Montek Singh Ahluwalia and others in charge of implementing policies are blissfully unaware of this fact, not to mention lesser mortals like myself.

    For the record, the fact that a suboptimal policy is being followed because of political considerations does not change the fact that it *is* suboptimal. As an economist, I have to say that the policy is suboptimal: what else can I say? That does not mean that I am unaware of the practical problems in changing the current policy. And that is all I have to say on this topic.

    Comment by economist — August 3, 2006 @ 2:21 pm

  22. Dear economist,
    Thank you for the wishes. Hope to engage in further academic debates with you.

    Comment by Alex — August 3, 2006 @ 6:43 pm

  23. I just saw this post, after 22 comments! A related conversation I had with Gautam Bastian over at his blog might be of interest to you all. Sorry for the hit and run comment, but my laptop juice is running out and I am late for a meeting:-(

    Comment by Crazyfinger — August 3, 2006 @ 11:44 pm

  24. Economist, honestly I think the reasoning was not subtle at all, and I think any smart person, not least our politicians
    who have to think daily about such problems, is quite capable of it.

    And don’t try to whitewash the political viability issue as if it is something top economists in India consider the first thing in the morning. Sure, the buereaucrats and the politicians have to consider it; it’s their job; but what I want is for mainstream economists to consider it.

    For it is from them that the truly good solutions can arise.

    Indeed, I’m not saying the question is non-obvious; I’m saying that it is the answer which is non-obvious; and that it’s being clouded by Friedmanian ideologues, it’s not being pursued. Not least because it is extremely difficult.

    For one, I could not find good politico-economic analyses on Indian labor policy.

    I might be wrong, perhaps teh top Indian economists do have the sort of vibrant tab on the political pulse that teh top American economists have; if so I would be one of the happiest persons to know that.

    Comment by seven_times_six — August 4, 2006 @ 8:26 pm

  25. How many Indian economists work do you know? Could you give me a reference to one who is representative of the caricature that you have of Indian economists?

    There is a much simpler explanation as to why politicians are not willing to touch the labour reform issue. Many of them have trade unions of their own and they are obviously reluctant to do anything to offend their support base. This is true of the BJP, the Left, Congress the DMK, AIADMK, Shiv Sena etc. As further evidence, note that many of them are willing to make exceptions in the sectors where there is no trade union. Witness the curious fact that the left front in Bengal has banned strikes in the IT sector where of course, there is no trade union.

    I have to clarify one thing: I do not think that your assertion that labour reforms will cause large unemployment in the short run is correct. I only said that the reasoning is somewhat subtle. But I don’t think it is right and here’s why. The organized sector employs only 7-8% of the total labour force. Sure, some workers will get unemployed but there is no reason to believe that there will be large scale unemployment. Much of the overemployment is in the public sector and I don’t see those firms laying off anyone. The private sector have already optimized their behaviour (in terms of the number of workers they hire) and I don’t see them laying off large number of workers either. Do you have any reason to believe the contrary? I have asked you this before and you ducked it claiming the onus is on me. I am confident you will continue to duck the issue.

    Finally, I am struck by your arrogance. You claim you are not an economist and don’t know much about the microeconomic situation, but for sure, you know that Indian economists are not doing something right. Yes, of course…as I said, I await the name of one Indian economist who meets your caricature.

    And of course, you will not acknowledge that you made an incorrect inference about me.

    Comment by economist — August 5, 2006 @ 1:15 am

  26. Do you believe there are real Political Parties / Politicians in India?
    =======================================================================

    There are no real political parties or politicians in India after emergency period, all political parties and politicians(chumchas) are funded by big business houses, they do what they are asked to do.

    Need proof?
    ===========

    Last time I saw political parties collecting election fund “house to house” from ordinary citizens is during 1971 general elections. Think about it, if you are an ordinary citizen, has any political party in India contacted you to join them or asked for election contribution in last 30 years? why not? think…..

    Comment by GeneralPublic — August 5, 2006 @ 8:02 pm

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