The right time for labour market reform is now

In my first job out of business school with Hindustan Lever, as Area Sales Manager I had a team of over 20 unionized salesmen. I ran a Voluntary Retirement Scheme in my first year and then again in my third year by which time we were down to half the original team size. Yet we introduced new brands in the market, grew our sales and in general did well as a team.

In my third year I took over a small new business of hot beverage vending for Lipton (at that time a division of HLL). The business was small but growing rapidly as we expanded our city coverage. In Sales, Distribution and Service we had about 50 people. Of this the number of direct Hindustan Lever employees was 2. The rest were all outsourced, contract or distributor’s employees.

I then moved to Infosys in the US and over my 11 years there, hired scores of employees onto the company’s US payrolls. I also had to let go of some people for performance or other reasons. At all times, I was acutely aware that I myself was an ‘At Will’ employee. I could be fired with two week’s wages without giving a reason. As long as the reason was not discriminatory (race, sex, religion etc.) I could not bring legal action upon the company.

My experience with the vastly different labour environment in both India and the US has driven home a very important lesson – a business exists to make money for its investors, not to provide employment. And that is, paradoxically, the best way to generate employment.

Let’s take a look at how India’s labour laws distort the business environment and harm employment and employees:

1. It discourages capital investment – particularly in service oriented industries. Investing capital means taking risks. Market risk – the risk that the business may not succeed – is a risk that ‘comes with the territory’. In most countries, investors know that if their business fails in the market, they close down the business, sell off the assets at knocked-down prices, book the loss and take the remaining capital to some other investment opportunity. However, in India, failure, or a downturn, in the market also means that you are still saddled with the payroll costs because you can’t restructure or layoff anybody. You can’t exit the business because employees will lose jobs. That’s something investors don’t have to deal with in most countries. You look at so many rusting factories in every major city in the country where the factory owner has not been able to layoff employees even when the networth of the company has gone down to zero, and you wonder – what a colossal waste of assets. You also wonder –  what do future investors think when they see these rust-buckets? More likely than not it’s – ‘That could be my investment 10 years from now.’

2. It provides no incentive for raising productivity through automation. Look at all the government offices or offices that have unionized staff like banks. To the last one, they opposed computerization. Why? because it could do the job faster and so it would reduce the number of jobs.

Yes it will and that is a good thing. Doing more work with fewer people raises productivity. Productivity raises incomes. The developed world’s prosperity is entirely linked to higher productivity. Also higher productivity creates the surplus (or the profit) that can be invested to create more jobs.

3. If you want to produce a quality product or service it needs carrots AND sticks. With an employee who is not performing, you train, you mentor, you put them on Performance Improvement Plans. But in the end, the employee needs to know that if his performance does not improve he can lose his job. Without this freedom for businesses to manage for performance, it may be possible to compete against companies who are similarly hampered, but it is a clear disadvantage in the global market.

4. It pushes employment generation into the informal sector. In my second stint at Levers I would have loved to hire people directly into the company instead of outsourcing critical functions like Sales. With the Levers brand name as an employer we would have got great talent which would have been better for the company. However, Levers would not do that for a new business that could have failed leaving them with employees they wouldn’t know what to do with. So all of the hiring was done by outsourced contract firms. Did these employees get the PF and benefits they would have got at Levers? I doubt that very much. I don’t think these contract firms even paid any taxes since they were probably classified as Small Scale.

In summary, the current labour laws in India distort the business environment to where it reduces employment generation by discouraging investment, reduces income growth by discouraging productivity increases, reduces quality by taking away the freedom to manage for performance and pushes employment generation into the informal sector.

Whenever I bring this up with people in industry in India, I am given many reasons why this is not a problem. Someone says ‘Only 20% of my workforce is unionized, I just work around them’. Another one will say ‘If you really want to fire an employee for performance, it can be done.’ But most of all the reason I get is ‘But the economy is doing so well why do we need to think about redundancies and labour flexibility?’ On the contrary, it is because the economy is doing so well that this is the right time for labour reform.

I believe this is the most important reform that government must now address. However, this is also the most difficult. Dismantling industrial licensing was like a walk in the park compared to this. With the government dependent upon the CPI(M) to stay in power makes it almost impossible to do major reforms. But major one-shot reforms aren’t the right answer anyway. There should be a 10 year road map on labour reform. But starting now. Let’s begin the discussion.


  1. I just discovered your blog, it provides an interesting perspective on things in India even though I am located in the US.

    Labor market flexibility is crucial to improving economic productivity in India and especially contintental Europe. The US has a lot of room for improvement too despite having weak unions.


  2. dexter says:

    “My experience with the vastly different labour environment in both India and the US has driven home a very important lesson – a business exists to make money for its investors, not to provide employment. And that is, paradoxically, the best way to generate employment.”
    Interesting! 🙂

    Wasnt the primary purpose of unions to collectively bargain for employees? Throughout the article you are assuming that the management is ALWAYS free and fair. they would always do the best of things for their employees even while letting them go. I wonder how much of this is really applicable to indian business which has mainly been family driven and open to the whims and fancies of people running it.

    Its true that the unions because of their vested interests has actually reduced productivity, but if it wasnt for them , then their would be no control over the management. Can a poor person really fight it out with an organization, a system in a country like india which has a poor legal system?? Also employability is a big issue.For someone higher up there, its easy to find a new job. But for ppl who have low skills, its almost as losing their entire life. thats why Companies like the TATA group try to help their employees in finding jobs after being laid off.

    And yes , a company is there to create shareholder value , but its also answerable to its employees to an extent. Push the shareholder value funda to the max and you will find cases like Enron and worldcom.


  3. Swapnil says:

    I don’t think there is a case for labour reforms in India if you look at the EFFORT vs. VALUE equation. The government will end up spending a lot of time and energy on any meaningful labour reform and get very little in return. The industry has learned to work around the rigid labour laws (yes! this does push employment into the informal sector).

    A recent ADB book “Labor Markets in Asia: Issues and Perspectives” argues that labor market policies are not the main explanation for the increase in unemployment and underemployment across Asia. The book says that each percentage-point of economic growth creates fewer jobs today than a decade earlier. A one percent increase in GDP is not creating as many jobs as it used to create earlier!! This shows an increase in productivity despite rigid labour laws.

    The same book suggests higher public investments in rural infrastructure to achieve higher employment and growth. I would tend to agree with this. The Indian government for e.g. should look at implementing a program to provide reliable and quality power supply to every village in the country. Successful implementation of such a program will help the industry and workforce much more than labour reforms.

    The biggest bottleneck today for India is infrastructure whether it is roads, railways, airports or power. It makes more sense for the government to focus on creating infrastructure than waste time and energy on labour reforms.

    It does not matter if a job is created on Hindustan Lever’s payroll or on some contract firm’s payroll as long as the job is created!!


  4. ila says:

    I wonder if anyone has asked the leftists how they define capital risk ?
    Chances are they would prefer to beleive it doesnt exist because for them, if you have capital, it is you bounden duty to hand it over to the state in any form.

    And the only way this govt will be able to arm twist the left is to keep publiscising the Rs. 4000 odd crore worth of assets built up by the LDF in Kerala. This was reported in the Eco Times during mid 2005.


  5. Naveen says:

    I have been skimming through the contents of your blog. Your questions and insights in the functioning of markets definitely makes good reading. Keep it up with more personal accounts!


  6. dhulis says:

    I think the rationale for having labour reforms linked to productivity is a good idea. However, it is only one part of a solution, which should also include social aspects such as security, corporate governance that is fair and trustworthy.


  7. My $ 0.02 says:

    Kudos on another very well written article. The case for labor reforms when economy is doing well is valid.

    However, one needs to be sure that the circumstances are right to reform labor laws.

    Between the two main types of resources, capital and labor, the former is more fluid / flexible than the latter. Its difficult to re-skill people or migrate them to other geography as compared to selling the factory and investing somewhere else. When there is too much of a flexibility difference between the two resources, there exist risks of system failure.

    The same case applies between domestic capital and FII. In case of crisis FII flies away in no time leaving the financial markets in shambles (S E Asia in late 90’s).

    So to stave off these crises one has to ensure that skin of all parties (capital investor and labor) is in the game.

    The fluidity logic also explains why IT / ITES industry does not have labor unions. The labor here can very well move across firms (even industries) and are secure. In this scenario the labor doesnt care even an iota more than the capital about market risk. If this situation prevails in all industries concept of labor union will be redundant.

    Two questions emerge: [1] whether labor in all industries in India today enjoys the same flexibility as it does in IT / ITES?

    [2] What will bring this flexibility?

    Only fast growth in all industries will bring this labor flexibility. Then only labor reforms will be successful. It is analogus to making Capital Account convertibile only when the growth is robust and coffers are overflowing.

    Irrespective of presence of left parties in govt., labor laws will either be reformed or become redundant (more probably the latter) when labor across the industries will enjoy the same flexibility as capital does. Without this condition even if govt. tries to reform, it might face a situation like France and will have to rollback.


Leave a Comment

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s